Pricing Default Risk: The good, the bad, and the anomaly

Sara Ferreira Filipe, Theoharry Grammatikos and Dimitra Michala

No 2014/23, EIF Working Paper Series from European Investment Fund (EIF)

Abstract: While empirical literature has documented a negative relation between default risk and stock returns, the theory suggests that default risk should be positively priced. We provide an explanation for this "default anomaly", by calculating monthly probabilities of default (PDs) for a large sample of firms and decomposing them into systematic and idiosyncratic components. The systematic part, measured as the PD sensitivity to aggregate default risk, is positively related to stock returns. Our results show that riskier stocks underperform because they have on average lower exposures to aggregate default risk.

Keywords: Default Risk; Merton model; Default Anomaly; Idiosyncratic Risk (search for similar items in EconPapers)
JEL-codes: G11 G12 G15 G33 (search for similar items in EconPapers)
Date: 2014
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Related works:
Journal Article: Pricing default risk: The good, the bad, and the anomaly (2016)
Working Paper: Pricing Default Risk: The Good, The Bad, and The Anomaly (2014)
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:eifwps:201423

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