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Default risk and stock returns: From a perspective of measurement errors

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  • Yang, Xiaolou
  • Hu, Yingyao

Abstract

The risk-return tradeoff underlies the conceptual framework for the asset pricing model and investment decisions under the efficient markets hypothesis. Many empirical study, however, demonstrate negative relation between credit risk and cross-section of stock returns. The main effort of this study is to attempt detangling the puzzle from the perspective of measurement error by representing the first treatment of a wide class of nonlinear models with discrete variables using instruments. We found measurement error has great impact on the relationship between stock returns and firm's risk of default. In addition, this relation found to be crucially dependent on credit cycles and firm financial status.

Suggested Citation

  • Yang, Xiaolou & Hu, Yingyao, 2024. "Default risk and stock returns: From a perspective of measurement errors," International Review of Economics & Finance, Elsevier, vol. 92(C), pages 1545-1561.
    • Handle: RePEc:eee:reveco:v:92:y:2024:i:c:p:1545-1561
    DOI: 10.1016/j.iref.2024.02.026
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    More about this item

    Keywords

    Measurement error; Default risk; Risk premium; Credit risk; Equity returns;
    All these keywords.

    JEL classification:

    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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