Size, Overreaction, and Book-to-Market Effects as Default Premia
Posted: 18 Dec 1996
Date Written: November 1996
This study explores the hypothesis that firm size, past returns, and book-to-market equity predict stock returns because of a premium for default or distress risk. Small size, low past returns, and high leverage all forecast default. However, book-to-market is only weakly correlated with default risk. The firm-specific probability of default is both statistically and economically significant in returns regressions. Furthermore, both size and past returns lose their ability to forecast returns when combined with default risk in regressions. The size and overreaction effects may be manifestations of a default premium, but the book-to-market effect cannot be described as a distress effect.
JEL Classification: G12
Suggested Citation: Suggested Citation