Systemic Default and Return Predictability in the Stock and Bond Markets
Charles A. Dice Center Working Paper No. 2016-2
62 Pages Posted: 27 Jan 2016 Last revised: 31 Mar 2021
Date Written: March 18, 2021
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. Systemic default spikes during recessions, is correlated with macroeconomic indicators, and predicts future realized defaults. More importantly, it predicts future equity and corporate bond index returns both in- and out-of-sample. Finally, we find that the cross-section of average stock returns is related to firm-level exposures to systemic default risk.
Keywords: Systemic risk, Joint default, Predictability, Stock returns, Bond returns
JEL Classification: E32, G12, G13, G17
Suggested Citation: Suggested Citation