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Is default risk priced in Australian equity? Exploring the role of the business cycle

  • Howard Chan
  • Robert Faff

    ()

  • Paul Kofman

Using an extensive Australian sample, we explore two related issues in the context of a default risk asset-pricing factor (DEF) over the business cycle: (a) whether a DEF can explain the size premium in the three-factor Fama–French (FF) model; and (b) whether a DEF has a separate role itself in a four-factor version of the FF model. While we find that the default factor does not explain the success of size, our evidence shows it has a complementary role to small minus big and high minus low. Notably, subgroups of test portfolios likely to seriously challenge any asset-pricing model show evidence that the four-factor model is not perfect. Finally, while we find that conditioning on the business cycle itself has little impact, when we condition on a leading indicator, it has a positive (negative) effect on the estimated default (market) risk premium.

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File URL: http://aum.sagepub.com/content/36/2/217.abstract
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Article provided by Australian School of Business in its journal Australian Journal of Management.

Volume (Year): 36 (2011)
Issue (Month): 2 (August)
Pages: 217-246

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Handle: RePEc:sae:ausman:v:36:y:2011:i:2:p:217-246
Contact details of provider: Web page: http://www.agsm.edu.au

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