Systemic Default and Return Predictability in the Stock and Bond Markets
Charles A. Dice Center Working Paper No. 2016-2
54 Pages Posted: 27 Jan 2016 Last revised: 7 Apr 2020
Date Written: March 22, 2020
Using a structural model of default, we construct a measure of systemic default defined as the probability that many firms default at the same time. We account for correlations in defaults between firms through exposures to common shocks. The systemic default measure spikes during recession periods and is correlated with macroeconomic indicators and future realized defaults. Furthermore, it predicts future equity and corporate bond returns, even after controlling for many existing return predictors, including tail risk. The predictability results are robust to out-of-sample tests.
Keywords: Systemic risk, Joint default, Predictability, Stock returns, Bond returns
JEL Classification: E32, G12, G13, G17
Suggested Citation: Suggested Citation