Credit risk and equity returns in China

Tangrong Li and Hui Lin

International Review of Economics & Finance, 2021, vol. 76, issue C, 588-613

Abstract: We examine how credit risk affects equity returns in China, where the financial system is dominated by debt-financing. Based on EDF (expected default frequency) measured by the KMV model, we construct a credit risk factor UMT (untrustworthy minus trustworthy). The empirical results show that UMT significantly improves the pricing effectiveness of the Fama-French five-factor model and that the modified model with the investment factor replaced by UMT is more applicable to the Chinese environment. Our results also show that stocks with higher credit risk have higher expected returns, and credit risk premiums are an essential part of equity returns in China.

Keywords: Credit risk; Equity return; Fama-French model; KMV Model (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:76:y:2021:i:c:p:588-613

DOI: 10.1016/j.iref.2021.07.002

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