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

Howard Chan, Robert Faff and Paul Kofman

Australian Journal of Management, 2011, vol. 36, issue 2, 217-246

Abstract: 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.

Keywords: asset pricing; business cycle; default risk (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (12)

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Persistent link: https://EconPapers.repec.org/RePEc:sae:ausman:v:36:y:2011:i:2:p:217-246

DOI: 10.1177/0312896211407528

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