Is there a Distress Risk Anomaly? Pricing of Systematic Default Risk in the Cross Section of Equity Returns
Review of Finance, Volume 22, Issue 2, March 2018, Pages 633–660
52 Pages Posted: 19 Nov 2009 Last revised: 21 Nov 2019
Date Written: August 8, 2017
The standard measures of distress risk ignore the fact that firm defaults are correlated and that some defaults are more likely to occur in bad times. We use risk premium computed from corporate credit spreads to measure a firm’s exposure to systematic variation in default risk. Unlike previously used measures, the credit risk premium explicitly accounts for the non-diversifiable component of distress risk. In contrast to prior findings in the literature, we find that stocks with higher systematic default risk exposures, have higher expected equity returns which are largely explained by the Fama-French risk factors. We confirm the robustness of these results by using an alternative systematic default risk factor for firms that do not have bonds outstanding.
Keywords: Default risk, systematic default risk, credit risk, distress risk anomaly, bankruptcy, credit spread, asset-pricing anomalies, pricing of default risk, corporate bonds
JEL Classification: G11, G12, G13, G14, G33
Suggested Citation: Suggested Citation