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Credit risk and equity returns in China

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  • Li, Tangrong
  • Lin, Hui

Abstract

We examine how credit risk affects equity returns in China, where the financial system is dominated by debt-financing. Based on EDF (expected default frequency) measured by the KMV model, we construct a credit risk factor UMT (untrustworthy minus trustworthy). The empirical results show that UMT significantly improves the pricing effectiveness of the Fama-French five-factor model and that the modified model with the investment factor replaced by UMT is more applicable to the Chinese environment. Our results also show that stocks with higher credit risk have higher expected returns, and credit risk premiums are an essential part of equity returns in China.

Suggested Citation

  • Li, Tangrong & Lin, Hui, 2021. "Credit risk and equity returns in China," International Review of Economics & Finance, Elsevier, vol. 76(C), pages 588-613.
    • Handle: RePEc:eee:reveco:v:76:y:2021:i:c:p:588-613
    DOI: 10.1016/j.iref.2021.07.002
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    3. Yi, Xingjian & Liu, Sheng & Wu, Zhouheng, 2022. "What drives credit expansion worldwide?——An empirical investigation with long-term cross-country panel data," International Review of Economics & Finance, Elsevier, vol. 80(C), pages 225-242.
    4. Thakerngkiat, Narongdech & Nguyen, Hung T. & Nguyen, Nhut H. & Visaltanachoti, Nuttawat, 2023. "Does fear spur default risk?," International Review of Economics & Finance, Elsevier, vol. 83(C), pages 879-899.

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    More about this item

    Keywords

    Credit risk; Equity return; Fama-French model; KMV Model;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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