Aggregate Distress Risk and Equity Returns

Hui Guo and Xiaowen Jiang

Journal of Banking & Finance, 2021, vol. 133, issue C

Abstract: The aggregate default probability is significantly priced in equities because of its close relation with uncertainty. Ceteris paribus, the aggregate default probability positively predicts stock market returns, and loadings on its changes correlate negatively with the cross-section of expected stock returns. These findings are consistent with multifactor models in which aggregate uncertainty is a determinant of the conditional equity premium and innovations in aggregate uncertainty are a systematic risk factor. By contrast, credit spreads have negligible explanatory power for expected stock returns. Contrary to the conventional wisdom, credit spreads are poor proxies for aggregate credit risk.

Keywords: financial distress risk; default probability; conditional equity premium; stock market variance; idiosyncratic variance; stock return predictability; financial leverage (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:133:y:2021:i:c:s0378426621002478

DOI: 10.1016/j.jbankfin.2021.106296

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