Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/104514 
Year of Publication: 
2009
Series/Report no.: 
Discussion Paper No. 2009-12
Publisher: 
Ludwig-Maximilians-Universität München, Fakultät für Betriebswirtschaft, München
Abstract: 
In this paper, we address the question whether the impact of default risk on equity returns depends on the financial system firms operate in. Using an implementation of Merton's option-pricing model for the value of equity to estimate firms' default risk, we construct a factor that measures the excess return of firms with low default risk over firms with high default risk. We then compare results from asset pricing tests for the German and the U.S. stock markets. Since Germany is the prime example of a bank-based financial system, where debt is supposedly a major instrument of corporate governance, we expect that a systematic default risk effect on equity returns should be more pronounced for German rather than U.S. firms. Our evidence suggests that a higher firm default risk systematically leads to lower returns in both capital markets. This contradicts some previous results for the U.S. by Vassalou/Xing (2004), but we show that their default risk factor looses its explanatory power if one includes a default risk factor measured as a factor mimicking portfolio. It further turns out that the composition of corporate debt affects equity returns in Germany. Firms' default risk sensitivities are attenuated the more a firm depends on bank debt financing.
Subjects: 
Asset pricing
Stochastic Discount Factor
Default Risk
JEL: 
G12
Persistent Identifier of the first edition: 
Document Type: 
Working Paper

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