Common Factors in Default Risk Across Countries and Industries

Kevin Aretz · Peter F. Pope

28 citations0/0 files storedEuropean Financial Management

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Credit Risk and Financial Regulations Corporate Insolvency and Governance Financial Distress and Bankruptcy Prediction

Abstract

Global economic crises appear to strongly affect corporate bankruptcy rates. However, several prior studies indicate that changes in default risk are strongly negatively related to equity returns, which in turn depend predominately on country-specific factors. This suggests that country effects – and not global effects – should dominate changes in default risk. To analyse this issue, we decompose changes in default risk, changes in the fundamental determinants of default risk and equity returns into global, country and industry effects. We proxy for default risk through Merton (1974) default risk estimates and CDS rates. Our evidence reveals that changes in default risk always depend most strongly on global and industry effects. However, the magnitude of country effects in equity returns correlates positively with economic stability, rendering it dependent on the sample period. Our results have implications for the management of credit-sensitive securities.

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1973The Pricing of Options and Corporate Liabilities 1993Common risk factors in the returns on stocks and bonds 1974ON THE PRICING OF CORPORATE DEBT: THE RISK STRUCTURE OF INTEREST RATES*1994Corporate Debt Value, Bond Covenants, and Optimal Capital Structure 2001Forecasting Bankruptcy More Accurately: A Simple Hazard Model 2001Extreme Correlation of International Equity Markets 2008In Search of Distress Risk 2008Forecasting Default with the Merton Distance to Default Model

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