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Is there a distress risk anomaly ? pricing of systematic default risk in the cross section of equity returns

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  • Anginer, Deniz
  • Yildizhan, Celim

Abstract

The standard measures of distress risk ignore the fact that firm defaults are correlated and that some defaults are more likely to occur in bad times. The paper uses risk premium computed from corporate credit spreads to measure a firm's exposure to systematic variation in default risk. Unlike previously used measures that proxy for a firm's physical probability of default, credit spreads proxy for a risk-adjusted default probability and thereby explicitly account for the non-diversifiable component of distress risk. In contrast to prior findings in the literature, the authors find that stocks that have higher credit risk premia, that is stocks with higher systematic default risk exposures, have higher expected equity returns. Consistent with structural models of default, they show that the premium to a high-minus-low systematic default risk hedge portfolio is largely explained by the market factor. The authors confirm the robustness of these results by using an alternative systematic default risk factor for firms that do not have bonds outstanding. The results show no evidence of firms with high systematic default risk exposure delivering anomalously low returns.

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 5319.

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Date of creation: 01 Jan 2010
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Handle: RePEc:wbk:wbrwps:5319

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Keywords: Debt Markets; Mutual Funds; Emerging Markets; Bankruptcy and Resolution of Financial Distress; Deposit Insurance;

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Citations

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Cited by:
  1. Anginer, Deniz & Warburton, A. Joseph, 2010. "The Chrysler effect : the impact of the Chrysler bailout on borrowing costs," Policy Research Working Paper Series 5462, The World Bank.
  2. Charles W. Calomiris & Inessa Love & Maria Soledad Martinez Peria, 2010. "Crisis “Shock Factors” and the Cross-Section of Global Equity Returns," NBER Working Papers 16559, National Bureau of Economic Research, Inc.
  3. Ali K. Ozdagli, 2010. "The distress premium puzzle," Working Papers 10-13, Federal Reserve Bank of Boston.
  4. Ferreira Filipe, Sara & Grammatikos, Theoharry & Michala, Dimitra, 2014. "Pricing Default Risk: The Good, The Bad, and The Anomaly," MPRA Paper 53373, University Library of Munich, Germany.
  5. Jens Hilscher & Mungo Wilson, 2011. "Credit ratings and credit risk," Working Papers 31, Brandeis University, Department of Economics and International Businesss School.

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