Is There a Distress Risk Anomaly? Corporate Bond Spread as a Proxy for Default Risk

Although financial theory suggests a positive relationship between default risk and equity returns, recent empirical papers find anomalously low returns for stocks with high probabilities of default. The authors show that returns to distressed stoc...

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Bibliographic Details
Main Authors:	Anginer, Deniz, Yildizhan, Celim
Format:	Policy Research Working Paper
Language:	English
Published:	2012
Subjects:	ABSOLUTE PRIORITY RULE ACCOUNTING ASSET PRICES ASSET PRICING TESTS ASSET PRICING THEORIES ASSET RETURNS ASSET VALUE ASSET VALUES BANKRUPT BANKRUPTCIES BANKRUPTCY BANKRUPTCY FILINGS BANKRUPTCY REFORM BASIS POINTS BENCHMARK BENCHMARKS BID BOND DATA BOND ISSUE BOND MARKET BOND MATURITY BOND RATINGS BOND SPREAD BOND SPREADS BOND YIELD BOND YIELDS BOOK DEBT BOOK RATIO BOOK-TO-MARKET BOOK-TO-MARKET EQUITY BPS CALL OPTION CAPITAL ASSET CAPITAL ASSET PRICING CAPITAL ASSET PRICING MODEL CAPITAL MARKET CAPITAL STRUCTURE CDS CHARACTERISTIC PORTFOLIOS CHECKS CONSUMER PRICE INDEX CONVERTIBLE BONDS CORPORATE BANKRUPTCY CORPORATE BOND CORPORATE BOND MARKETS CORPORATE BOND RATINGS CORPORATE BONDS CORPORATE DEBT CORPORATE DEFAULT CORPORATE DEFAULTS CORPORATE YIELD CORPORATE-TREASURY YIELD COUPON CREDIT DEFAULT CREDIT DEFAULT SWAP CREDIT DEFAULT SWAPS CREDIT DERIVATIVES CREDIT QUALITY CREDIT RATING CREDIT RATINGS CREDIT RISK CREDIT SPREAD CREDIT SPREADS DEBT DEBT SECURITIES DEFAULT INFORMATION DEFAULT LOSSES DEFAULT PROBABILITIES DEFAULT PROBABILITY DEFAULT RATES DEFAULT RISK DERIVATIVE DISTRESSED FIRMS DIVIDEND DIVIDEND RATE DIVIDENDS DUMMY VARIABLE DUMMY VARIABLES DYNAMIC PANEL EARNINGS BEFORE INTEREST ECONOMIC FLUCTUATIONS EFFICIENT MARKET EQUITIES EQUITY MARKET EQUITY MARKET VALUE EQUITY PORTFOLIO EQUITY PREMIUM EQUITY RETURN EQUITY RETURNS EQUITY VALUE EQUITY VOLATILITY EVENT OF DEFAULT EXPECTED RETURNS FACE VALUE FACE VALUE OF DEBT FEDERAL RESERVE FINANCIAL DISTRESS FINANCIAL MARKETS FINANCIAL OBLIGATIONS FINANCIAL STUDIES FIXED INCOME FIXED INCOME SECURITIES FLOATING INTEREST RATES FLOATING RATE FLOATING RATE DEBT FORECASTS GROWTH STOCKS HAZARD RATE HUMAN CAPITAL IDIOSYNCRATIC RISK ILLIQUIDITY INDIVIDUAL STOCK INSURANCE INTEREST-RATE INTERNATIONAL BANK LEVERAGE LEVERAGE INCREASES LIQUIDITY LIQUIDITY POSITION LIQUIDITY RISK LITERATURE ON BANKRUPTCY LOSS AVERSION LOSS RATE LOSS RATES MARKET CAPITALIZATION MARKET EFFICIENCY MARKET EQUILIBRIUM MARKET EQUITY MARKET LIQUIDITY MARKET VALUE MARKET VALUE OF ASSETS MARKET VALUE OF EQUITY MARKET VALUES MATURITIES MATURITY MICROSTRUCTURE MODELS OF BANKRUPTCY MOMENTUM FACTOR MUTUAL FUND MUTUAL FUND MANAGERS MUTUAL FUND PERFORMANCE MUTUAL FUND PORTFOLIO MUTUAL FUND PORTFOLIO HOLDINGS POLITICAL ECONOMY POOR PERFORMERS PORTFOLIO PORTFOLIO HOLDINGS PORTFOLIO RETURN PORTFOLIO RETURNS PREVIOUS STUDIES PRICE PER SHARE PRIVATE EQUITY PROBABILITIES OF DEFAULT PROBABILITY OF BANKRUPTCY PROBABILITY OF DEFAULT PROFITABILITY RATING AGENCIES RAW RETURN RAW RETURNS RETURN RETURN DIFFERENCES RETURNS ON STOCKS RISK ASSETS RISK FACTOR RISK FACTORS RISK MEASURE RISK MEASURES RISK OF BANKRUPTCY RISK OF DEFAULT RISK PREMIUM RISK-FREE RATE RISK-NEUTRAL PROBABILITIES RISKY INVESTMENTS ROBUSTNESS CHECKS S&P SECURITY RETURNS SHAREHOLDER STATISTICAL ANALYSES STOCK CHARACTERISTIC STOCK CHARACTERISTICS STOCK MARKET STOCK MARKET EFFICIENCY STOCK PORTFOLIOS STOCK RETURNS STOCK VALUATION STOCKS SURVIVORSHIP BIAS SWAP SWAP MARKET SYSTEMATIC RISK TRADING TRADING COSTS TREASURY TREASURY BILL TREASURY BILL RATE TREASURY RATE TREASURY RATES TREASURY YIELD SPREAD TURNOVER VALUATION VALUE OF ASSETS VALUE STOCKS VOLATILITY WARRANTS WEALTH WORKING CAPITAL YIELD SPREAD YIELD SPREADS
Online Access:	http://www-wds.worldbank.org/external/default/main?menuPK=64187510&pagePK=64193027&piPK=64187937&theSitePK=523679&menuPK=64187510&searchMenuPK=64187283&siteName=WDS&entityID=000158349_20100526134855 http://hdl.handle.net/10986/3804

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Summary:	Although financial theory suggests a positive relationship between default risk and equity returns, recent empirical papers find anomalously low returns for stocks with high probabilities of default. The authors show that returns to distressed stocks previously documented are really an amalgamation of anomalies associated with three stock characteristics -- leverage, volatility and profitability. In this paper they use a market based measure -- corporate credit spreads -- to proxy for default risk. Unlike previously used measures that proxy for a firm's real-world probability of default, credit spreads proxy for a risk-adjusted (or a risk-neutral) probability of default and thereby explicitly account for the systematic component of distress risk. The authors show that credit spreads predict corporate defaults better than previously used measures, such as, bond ratings, accounting variables and structural model parameters. They do not find default risk to be significantly priced in the cross-section of equity returns. There is also no evidence of firms with high default risk delivering anomalously low returns.

Is There a Distress Risk Anomaly? Corporate Bond Spread as a Proxy for Default Risk

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