I just read an interesting paper, The Pricing of Investment Grade Credit Risk during the Financial Crisis by Joshua D. Coval, Jakub W. Jurek, and Erik Stafford. This paper develops a pricing model for bonds which explains the current explosion in credit spreads, and the consequent collapse of our financial system, in terms of an incorrect pricing of systematic default risk pro articulum. The authors, who are at Harvard Business School and Princeton, claim that their model shows that the markets are now more-or-less correctly pricing this systematic default risk per articulum. They argue that the data supports this hypothesis and not that there is an extreme liquidity discount currently distorting the prices of these instruments.

This is essentially what I was arguing in my post on the mispricing of correlation risk, from September, 2008. I suggested that the market had assumed that default was entirely idiosyncratic yet we were experiencing a systematic, or correlated, default and the response was to dramatically discount credit derivative securities.