Do Stock Returns Really Decrease with Default Risk? New International Evidence
This study constructs a unique dataset of bankruptcy filings for a large sample of non U.S. firms in 14 developed markets and sheds new light on the cross sectional relation between default risk and stock returns. Using the flexible approach of Campbell et al. (2008) to estimate default risk probabilities, this is the first study to offer conclusive evidence supporting the existence of an economically and statistically significant positive default risk premium in international markets. This finding is robust to different portfolio weighting schemes, data filters, sample periods and holding period definitions, and holds using both in sample estimates of default probabilities during the period 1992 2010 and out of sample estimates during the period 2000 2010. We also show that the magnitude of the default risk premium is contingent upon a series of firm characteristics.
Manag. Sci.