Is Default Risk Priced in Equity Returns?

Caren Yinxia Nielsen

No 2013/2, Knut Wicksell Working Paper Series from Lund University, Knut Wicksell Centre for Financial Studies

Abstract: Size and book-to-market equity (BM) strongly explain stock returns’ cross section; the risk they capture is the relative distress of small and value stocks. This study examines the default risk’s pricing power, measured by U.S. firms’ market-revealed credit-default-swap premiums (2004–2010), in average returns across stocks. It also explores whether the size and BM effects stem from proxying the default-risk effect. In the tests, size dominates the size–default-risk effect, while BM and default risk work together. Therefore, size and BM partially proxy the default-risk effect. As expected, size is priced with a negative risk premium and BM is positive. However, higher default risk only engenders higher expected stock returns when BM is below a threshold and unpriced. Additionally, size indeed proxies sensitivity to the default-risk factor. Furthermore, the Fama–French factors SMB (small-minus-big) and HML (high-minus-low) share some common information with the default-risk factor in asset-pricing tests.

Keywords: Asset Pricing; Equity Returns; Size Effect; Book-to-Market Effect; Default-Risk Effect; Credit-Default-Swap Premium (search for similar items in EconPapers)
JEL-codes: G12 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2013-01-24
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.lusem.lu.se/media/kwc/working-papers/kwc-wp-2013-2.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 404 Not Found (http://www.lusem.lu.se/media/kwc/working-papers/kwc-wp-2013-2.pdf [301 Moved permanently]--> https://www.lusem.lu.se/media/kwc/working-papers/kwc-wp-2013-2.pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:hhs:luwick:2013_002

Access Statistics for this paper

More papers in Knut Wicksell Working Paper Series from Lund University, Knut Wicksell Centre for Financial Studies Knut Wicksell Centre for Financial Studies, Lund University School of Economics and Management, P.O. Box 7082, S-220 07 Lund, Sweden. Contact information at EDIRC.
Bibliographic data for series maintained by Jens Forssbaeck () and Frederik Lundtofte ( this e-mail address is bad, please contact ).