Systemic Default and Return Predictability in the Stock and Bond Markets

Charles A. Dice Center Working Paper No. 2016-2

Fisher College of Business Working Paper No. 2016-03-02

54 Pages Posted: 27 Jan 2016 Last revised: 7 Apr 2020

See all articles by Jack Bao

Jack Bao

University of Delaware - Department of Finance

Kewei Hou

Ohio State University (OSU) - Department of Finance

Shaojun Zhang

The Ohio State University

Date Written: March 22, 2020

Abstract

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

Bao, Jack and Hou, Kewei and Zhang, Shaojun, Systemic Default and Return Predictability in the Stock and Bond Markets (March 22, 2020). Charles A. Dice Center Working Paper No. 2016-2, Fisher College of Business Working Paper No. 2016-03-02, Available at SSRN: https://ssrn.com/abstract=2722784 or http://dx.doi.org/10.2139/ssrn.2722784

Jack Bao

University of Delaware - Department of Finance ( email )

Alfred Lerner College of Business and Economics
Newark, DE 19716
United States

Kewei Hou (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-0552 (Phone)
614-292-2418 (Fax)

Shaojun Zhang

The Ohio State University

2100 Neil Avenue
Columbus, OH 43210-1144
United States

HOME PAGE: http://sites.google.com/view/zhangshaojun

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