Default risk and equity returns: Australian evidence

Philip Gharghori, Howard Chan, Robert Faff*

*Corresponding author for this work

Research output: Contribution to journalArticleResearchpeer-review

20 Citations (Scopus)

Abstract

We test whether default risk is related to equity returns using the Fama and MacBeth [Fama, E.F., MacBeth, J., 1973. Risk, return, and equilibrium: empirical tests. Journal of Political Economy 81, 607-636.] regression framework. The proxy we use for default risk is the default probability obtained from option-based models. Our findings show that default probability is negatively related to returns. While we find that size and book-to-market are related to default risk, the ability of these variables to explain cross-sectional variation in returns is not because they are proxying default risk. Further, our evidence suggests that the negative relationship between default probability and returns is not due to a leverage, volatility or momentum effect.

Original languageEnglish
Pages (from-to)580-593
Number of pages14
JournalPacific Basin Finance Journal
Volume17
Issue number5
DOIs
Publication statusPublished - Nov 2009
Externally publishedYes

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