Modern Economy

Volume 7, Issue 14 (December 2016)

ISSN Print: 2152-7245   ISSN Online: 2152-7261

Google-based Impact Factor: 0.96  Citations  

Leverage, Default Risk, and the Cross-Section of Equity and Firm Returns

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DOI: 10.4236/me.2016.714143    1,865 Downloads   3,612 Views  Citations

ABSTRACT

I examine the two components of default risk and how they relate to stock returns, size, and book-to-market. High default risk firms do not necessarily have high levels of systematic asset risk. I show that the two components of default risk, asset volatility and leverage, are negatively related. I provide evidence that leverage differences across firms are not reflected in equity betas. Therefore, I construct firm returns using estimates of firm’s debt returns. The results indicate that a large part of the value premium and some of the size premium can be explained by differences in leverage across firms.

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Hood III, F. (2016) Leverage, Default Risk, and the Cross-Section of Equity and Firm Returns. Modern Economy, 7, 1610-1639. doi: 10.4236/me.2016.714143.

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