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| Pricing of Default Risk Revisited: Corporate bond spread as a proxy for default risk by Deniz Anginer of University of Michigan, and November 24, 2008 Abstract: This paper explores the pricing of default risk in the cross section of equity returns using US corporate bond data during the 1986 to 2006 time period. 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 bankruptcy. In this paper we use a market based measure - corporate credit spreads - to proxy for default risk. We show that credit spreads predict corporate defaults better than previously used measures, such as, bond ratings and accounting based parameters. We 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. Our results suggest that default risk is not a priced risk factor. JEL Classification: G11, G12, G13, G14. Keywords: Default risk, bankruptcy, credit spread, bond spread, distress risk, credit rating, asset- pricing anomalies, pricing of default risk, corporate bonds, NAIC, FISD, TRACE, Lehman Brothers Fixed Income Database. Download paper (524K PDF) 33 pages
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