Systemic Default and Return Predictability in the Stock and Bond Markets

Charles A. Dice Center Working Paper No. 2016-2

Fisher College of Business Working Paper No. 2016-03-02

62 Pages Posted: 27 Jan 2016 Last revised: 31 Mar 2021

See all articles by Jack Bao

Jack Bao

University of Delaware - Department of Finance

Kewei Hou

Ohio State University (OSU) - Department of Finance

Shaojun Zhang

The Ohio State University; The Vanguard Group, Inc.

Date Written: March 18, 2021

Abstract

We construct a measure of systemic default defined as the probability that many firms default at the same time. We account for correlations in defaults between firms through exposures to common shocks. Systemic default spikes during recessions, is correlated with macroeconomic indicators, and predicts future realized defaults. More importantly, it predicts future equity and corporate bond index returns both in- and out-of-sample. Finally, we find that the cross-section of average stock returns is related to firm-level exposures to systemic default risk.

Keywords: Systemic risk, Joint default, Predictability, Stock returns, Bond returns

JEL Classification: E32, G12, G13, G17

Suggested Citation

Bao, Jack and Hou, Kewei and Zhang, Shaojun, Systemic Default and Return Predictability in the Stock and Bond Markets (March 18, 2021). Charles A. Dice Center Working Paper No. 2016-2, Fisher College of Business Working Paper No. 2016-03-02, Available at SSRN: https://ssrn.com/abstract=2722784 or http://dx.doi.org/10.2139/ssrn.2722784

Jack Bao

University of Delaware - Department of Finance ( email )

Alfred Lerner College of Business and Economics
Newark, DE 19716
United States

Kewei Hou (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-0552 (Phone)
614-292-2418 (Fax)

Shaojun Zhang

The Ohio State University

2100 Neil Avenue
Columbus, OH 43210-1144
United States

HOME PAGE: http://sites.google.com/view/zhangshaojun

The Vanguard Group, Inc. ( email )

100 Vanguard Blvd
Malvern, PA 19355
United States

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