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Default risk and equity returns: Australian evidence

  • Gharghori, Philip
  • Chan, Howard
  • Faff, Robert

We test whether default risk is related to equity returns using the Fama and MacBeth [Fama, E.F., MacBeth, J., 1973. Risk, return, and equilibrium: empirical tests. Journal of Political Economy 81, 607-636.] regression framework. The proxy we use for default risk is the default probability obtained from option-based models. Our findings show that default probability is negatively related to returns. While we find that size and book-to-market are related to default risk, the ability of these variables to explain cross-sectional variation in returns is not because they are proxying default risk. Further, our evidence suggests that the negative relationship between default probability and returns is not due to a leverage, volatility or momentum effect.

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Article provided by Elsevier in its journal Pacific-Basin Finance Journal.

Volume (Year): 17 (2009)
Issue (Month): 5 (November)
Pages: 580-593

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Handle: RePEc:eee:pacfin:v:17:y:2009:i:5:p:580-593
Contact details of provider: Web page: http://www.elsevier.com/locate/pacfin

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