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Is There a Distress Risk Anomaly? Pricing of Systematic Default Risk in the Cross Section of Equity Returns

50 Pages Posted: 20 Apr 2016  

Deniz Anginer

World Bank Research

Celim Yildizhan

University of Georgia - C. Herman and Mary Virginia Terry College of Business

Multiple version iconThere are 2 versions of this paper

Date Written: January 1, 2010

Abstract

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. The paper uses risk premium computed from corporate credit spreads to measure a firm's exposure to systematic variation in default risk. Unlike previously used measures that proxy for a firm's physical probability of default, credit spreads proxy for a risk-adjusted default probability and thereby explicitly account for the non-diversifiable component of distress risk. In contrast to prior findings in the literature, the authors find that stocks that have higher credit risk premia, that is stocks with higher systematic default risk exposures, have higher expected equity returns. Consistent with structural models of default, they show that the premium to a high-minus-low systematic default risk hedge portfolio is largely explained by the market factor. The authors confirm the robustness of these results by using an alternative systematic default risk factor for firms that do not have bonds outstanding. The results show no evidence of firms with high systematic default risk exposure delivering anomalously low returns.

Keywords: Debt Markets, Mutual Funds, Emerging Markets, Bankruptcy and Resolution of Financial Distress, Deposit Insurance

Suggested Citation

Anginer, Deniz and Yildizhan, Celim, Is There a Distress Risk Anomaly? Pricing of Systematic Default Risk in the Cross Section of Equity Returns (January 1, 2010). World Bank Policy Research Working Paper No. 5319. Available at SSRN: https://ssrn.com/abstract=1616477

Deniz Anginer (Contact Author)

World Bank Research ( email )

1818 H Street, NW
Washington, DC 20433
United States

Celim Yildizhan

University of Georgia - C. Herman and Mary Virginia Terry College of Business ( email )

Brooks Hall
Athens, GA 30602-6254
United States

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