Do Stock Returns Really Decrease With Default Risk?
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Do Stock Returns Really Decrease with Default Risk? New International Evidence
Kevin Aretz; Chris Florackis; Alexandros Kostakis
- ?Digital Research Alliance of Canada
- ?Alliance Manchester Business School
- University of Liverpool
- ?University of Liverpool (UK)
- University of Manchester
- ?University of Liverpool Management School
- ?University of Manchester - Manchester Business School
Strategy in a nutshell
This strategy estimates 12-month default probabilities for firms in 14 countries using LOGIT models and adjusted Campbell indicators. Stocks are sorted by default risk, forming quintile portfolios; the strategy goes long high-risk and short low-risk stocks.
Economic rationale
Default risk premiums vary across countries based on creditor protections and shareholder power. Riskier distressed firms, especially with high asset tangibility, offer higher premiums. The non-diversifiable, systematic component of default risk primarily drives returns.
Backtest performance
Annualised return13.42%
Volatility16.57%
Sharpe ratio0.81