Credit Rating Downgrade Risk on Equity Returns

20 Pages Posted: 25 Jun 2020 Last revised: 20 Jul 2021

See all articles by Periklis Brakatsoulas

Periklis Brakatsoulas

Charles University in Prague - Institute of Economic Studies

Jiri Kukacka

Charles University - Institute of Economic Studies; Czech Academy of Sciences - Institute of Information Theory and Automation

Date Written: July 20, 2021

Abstract

We develop an asset pricing model to capture credit rating downgrade risk and suggest a new methodology to generate firm-level downgrade probabilities. Using credit transition matrices and rating histories from US issuers, we provide empirical evidence for a statistically significant positive downgrade risk premium. Stocks at higher risk of failure tend to deliver higher returns. The performance of the model remains robust across several panel data estimation methods. Panel Granger causality test results further indicate a Granger-causal relationship from credit rating transition probabilities to excess returns. Our paper thus provides the basis for further development and empirical validation of Fama-French-type models under financial distress.

Keywords: Asset Pricing, Credit Risk, Panel Data, Stock Returns, Transition Matrices

JEL Classification: G11, G12, G14, G41

Suggested Citation

Brakatsoulas, Periklis and Kukacka, Jiri, Credit Rating Downgrade Risk on Equity Returns (July 20, 2021). Available at SSRN: https://ssrn.com/abstract=3617559 or http://dx.doi.org/10.2139/ssrn.3617559

Periklis Brakatsoulas (Contact Author)

Charles University in Prague - Institute of Economic Studies ( email )

Opletalova 26
Praha 1, 11000
Czech Republic

Jiri Kukacka

Charles University - Institute of Economic Studies ( email )

Opletalova 26
Prague 1, CZ-11000
Czech Republic

HOME PAGE: http://ies.fsv.cuni.cz/en/contacts/people/58305408

Czech Academy of Sciences - Institute of Information Theory and Automation ( email )

Pod Vodarenskou vezi 4
Prague 8, CZ-18200
Czech Republic

HOME PAGE: http://www.utia.cas.cz/people/kukacka

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