IDEAS home Printed from https://ideas.repec.org/p/imf/imfwpa/2006-148.html
   My bibliography  Save this paper

Is Systematic Default Risk Priced in Equity Returns? A Cross-Sectional Analysis Using Credit Derivatives Prices

Author

Listed:
  • Mr. Jorge A Chan-Lau

Abstract

This paper finds that systematic default risk, or the event of widespread defaults in the corporate sector, is an important determinant of equity returns. Moreover, the market price of systematic default risk is one order of magnitude higher than the market price of other risk factors. In contrast to studies by Fama and French (1993, 1996 ) and Vassalou and Xing (2004), this paper uses a market-based measure of systematic default risk. The measure is constructed using price information from credit derivatives prices, namely the spreads of standardized single-tranche collateralized debt obligations on credit derivatives indices.

Suggested Citation

  • Mr. Jorge A Chan-Lau, 2006. "Is Systematic Default Risk Priced in Equity Returns? A Cross-Sectional Analysis Using Credit Derivatives Prices," IMF Working Papers 2006/148, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2006/148
    as

    Download full text from publisher

    File URL: http://www.imf.org/external/pubs/cat/longres.aspx?sk=19315
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Francis A. Longstaff & Sanjay Mithal & Eric Neis, 2005. "Corporate Yield Spreads: Default Risk or Liquidity? New Evidence from the Credit Default Swap Market," Journal of Finance, American Finance Association, vol. 60(5), pages 2213-2253, October.
    2. Hull, John & Predescu, Mirela & White, Alan, 2004. "The relationship between credit default swap spreads, bond yields, and credit rating announcements," Journal of Banking & Finance, Elsevier, vol. 28(11), pages 2789-2811, November.
    3. Michael S. Gibson, 2004. "Understanding the risk of synthetic CDOs," Finance and Economics Discussion Series 2004-36, Board of Governors of the Federal Reserve System (U.S.).
    4. Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
    5. Martin Lettau & Sydney Ludvigson, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 815-849, June.
    6. Miss Yinqiu Lu & Mr. Jorge A Chan-Lau, 2006. "Idiosyncratic and Systemic Risk in the European Corporate Sector: A CDO Perspective," IMF Working Papers 2006/107, International Monetary Fund.
    7. Francis A. Longstaff & Arvind Rajan, 2008. "An Empirical Analysis of the Pricing of Collateralized Debt Obligations," Journal of Finance, American Finance Association, vol. 63(2), pages 529-563, April.
    8. Robert J. Barro, 2005. "Rare Events and the Equity Premium," NBER Working Papers 11310, National Bureau of Economic Research, Inc.
    9. Roberto Blanco & Simon Brennan & Ian W. Marsh, 2004. "An empirical analysis of the dynamic relationship between investment grade bonds and credit default swaps," Working Papers 0401, Banco de España.
    10. John Lintner, 1965. "Security Prices, Risk, And Maximal Gains From Diversification," Journal of Finance, American Finance Association, vol. 20(4), pages 587-615, December.
    11. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    12. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    13. Maria Vassalou & Yuhang Xing, 2004. "Default Risk in Equity Returns," Journal of Finance, American Finance Association, vol. 59(2), pages 831-868, April.
    14. Roberto Blanco & Simon Brennan & Ian W. Marsh, 2005. "An Empirical Analysis of the Dynamic Relation between Investment‐Grade Bonds and Credit Default Swaps," Journal of Finance, American Finance Association, vol. 60(5), pages 2255-2281, October.
    15. Mehra, Rajnish & Prescott, Edward C., 1988. "The equity risk premium: A solution?," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 133-136, July.
    16. Mr. Jorge A Chan-Lau & Ms. Yoon Sook Kim, 2004. "Equity Prices, Credit Default Swaps, and Bond Spreads in Emerging Markets," IMF Working Papers 2004/027, International Monetary Fund.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Ferreira Filipe, Sara & Grammatikos, Theoharry & Michala, Dimitra, 2016. "Pricing default risk: The good, the bad, and the anomaly," Journal of Financial Stability, Elsevier, vol. 26(C), pages 190-213.
    2. Nielsen, Caren Yinxia, 2011. "Hidden in the Factors? The Effect of Credit Risk on the Cross-section of Equity Returns," Working Papers 2011:38, Lund University, Department of Economics, revised 01 Oct 2016.
    3. Yinxia G. Nielsen , Caren, 2013. "Is Default Risk Priced in Equity Returns?," Knut Wicksell Working Paper Series 2013/2, Lund University, Knut Wicksell Centre for Financial Studies.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Deniz Anginer & Çelim Yıldızhan, 2018. "Is There a Distress Risk Anomaly? Pricing of Systematic Default Risk in the Cross-section of Equity Returns [The risk-adjusted cost of financial distress]," Review of Finance, European Finance Association, vol. 22(2), pages 633-660.
    2. Peña, Juan Ignacio & Forte, Santiago, 2006. "Credit spreads: theory and evidence about the information content of stocks, bonds and cdss," DEE - Working Papers. Business Economics. WB wb063310, Universidad Carlos III de Madrid. Departamento de Economía de la Empresa.
    3. Hayette Gatfaoui, 2010. "Investigating the dependence structure between credit default swap spreads and the U.S. financial market," Annals of Finance, Springer, vol. 6(4), pages 511-535, October.
    4. J. Alsubaiei, Bader & Calice, Giovanni & Vivian, Andrew, 2021. "Sovereign CDS and mutual funds: Global evidence," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 73(C).
    5. Santiago Forte & Lidija Lovreta, 2015. "Time†Varying Credit Risk Discovery in the Stock and CDS Markets: Evidence from Quiet and Crisis Times," European Financial Management, European Financial Management Association, vol. 21(3), pages 430-461, June.
    6. repec:zbw:rwirep:0243 is not listed on IDEAS
    7. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, December.
    8. Giesecke, Kay & Longstaff, Francis A. & Schaefer, Stephen & Strebulaev, Ilya, 2011. "Corporate bond default risk: A 150-year perspective," Journal of Financial Economics, Elsevier, vol. 102(2), pages 233-250.
    9. Sydney Ludvigson, 2008. "The Research Agenda: Sydney Ludvigson on Empirical Evaluation of Economic Theories of Risk Premia," EconomicDynamics Newsletter, Review of Economic Dynamics, vol. 9(2), April.
    10. Martin Lettau & Sydney Ludvigson, 2001. "Resurrecting the (C)CAPM: A Cross-Sectional Test When Risk Premia Are Time-Varying," Journal of Political Economy, University of Chicago Press, vol. 109(6), pages 1238-1287, December.
    11. repec:gnv:wpaper:unige:76321 is not listed on IDEAS
    12. Guo, Hui & Savickas, Robert & Wang, Zijun & Yang, Jian, 2009. "Is the Value Premium a Proxy for Time-Varying Investment Opportunities? Some Time-Series Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(1), pages 133-154, February.
    13. Rahmi Erdem Aktug, 2015. "Empirical dynamics of emerging financial markets during the global mortgage crisis," Borsa Istanbul Review, Research and Business Development Department, Borsa Istanbul, vol. 15(1), pages 17-36, March.
    14. Ray Ball & Gil Sadka & Ayung Tseng, 2022. "Using accounting earnings and aggregate economic indicators to estimate firm-level systematic risk," Review of Accounting Studies, Springer, vol. 27(2), pages 607-646, June.
    15. Belke, Ansgar & Gokus, Christian, 2011. "Volatility Patterns of CDS, Bond and Stock Markets Before and During the Financial Crisis – Evidence from Major Financial Institutions," Ruhr Economic Papers 243, RWI - Leibniz-Institut für Wirtschaftsforschung, Ruhr-University Bochum, TU Dortmund University, University of Duisburg-Essen.
    16. Patrick Gagliardini & Elisa Ossola & Olivier Scaillet, 2016. "Time‐Varying Risk Premium in Large Cross‐Sectional Equity Data Sets," Econometrica, Econometric Society, vol. 84, pages 985-1046, May.
    17. Rahmi Erdem Aktug & Geraldo Vasconcellos & Youngsoo Bae, 2012. "The dynamics of sovereign credit default swap and bond markets: empirical evidence from the 2001 to 2007 period," Applied Economics Letters, Taylor & Francis Journals, vol. 19(3), pages 251-259, February.
    18. da Silva, Paulo Pereira & Rebelo, Paulo Tomaz & Afonso, Cristina, 2014. "Tail dependence of financial stocks and CDS markets: Evidence using copula methods and simulation-based inference," Economics - The Open-Access, Open-Assessment E-Journal (2007-2020), Kiel Institute for the World Economy (IfW Kiel), vol. 8, pages 1-27.
    19. Schuhmacher, Frank & Auer, Benjamin R., 2014. "Sufficient conditions under which SSD- and MR-efficient sets are identical," European Journal of Operational Research, Elsevier, vol. 239(3), pages 756-763.
    20. Gann, Philipp & Laut, Amelie, 2008. "Einflussfaktoren auf den Credit Spread von Unternehmensanleihen," Discussion Papers in Business Administration 4231, University of Munich, Munich School of Management.
    21. Ludvigson, Sydney C. & Ng, Serena, 2007. "The empirical risk-return relation: A factor analysis approach," Journal of Financial Economics, Elsevier, vol. 83(1), pages 171-222, January.
    22. Delatte, Anne-Laure & Gex, Mathieu & López-Villavicencio, Antonia, 2012. "Has the CDS market influenced the borrowing cost of European countries during the sovereign crisis?," Journal of International Money and Finance, Elsevier, vol. 31(3), pages 481-497.

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:imf:imfwpa:2006/148. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Akshay Modi (email available below). General contact details of provider: https://edirc.repec.org/data/imfffus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.