Aggregate Distress Risk and Equity Returns

44 Pages Posted: 1 Aug 2015

See all articles by Hui Guo

Hui Guo

University of Cincinnati - Department of Finance - Real Estate

Xiaowen Jiang

Western Connecticut State University - Ancell School of Business

Date Written: July 30, 2015

Abstract

We show in two ways that, ceteris paribus, investors require a positive return premium for taking aggregate distress risk. First, aggregate distress risk correlates positively with future excess stock market returns. Second, stocks that provide a poor hedge against aggregate distress risk have high expected returns. To reconcile our results with previous evidence of a negative default probability-return relation, we find that default probabilities are an inadequate measure of exposure to systematic distress risk. Consistent with George and Hwang’s (2010) tradeoff theory of capital structure, firms that are more susceptible to aggregate distress risk have a lower level of leverage.

Keywords: financial distress risk; default probability; conditional equity premium; stock market return predictability; idiosyncratic risk; and financial leverage

JEL Classification: G1

Suggested Citation

Guo, Hui and Jiang, Xiaowen, Aggregate Distress Risk and Equity Returns (July 30, 2015). Available at SSRN: https://ssrn.com/abstract=2637993 or http://dx.doi.org/10.2139/ssrn.2637993

Hui Guo (Contact Author)

University of Cincinnati - Department of Finance - Real Estate ( email )

College of Business
418 Carl H. Lindner Hall
Cincinnati, OH 45221
United States
513.556.7077 (Phone)
513.556.0979 (Fax)

HOME PAGE: http://homepages.uc.edu/~guohu/

Xiaowen Jiang

Western Connecticut State University - Ancell School of Business ( email )

Danbury, CT
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
126
Abstract Views
4,020
rank
270,816
PlumX Metrics