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I examine the two components of default risk and howthey relate to stock returns, size, and book-to-market. High default risk firmsdo not necessarily have high levels of systematic asset risk. I show that thetwo components of default risk, asset volatility and leverage, are negativelyrelated. I provide evidence that leverage differences across firms are notreflected in equity betas. Therefore, I construct firm returns using estimatesof firm’s debt returns. The results indicate that a large part of the valuepremium and some of the size premium can be explained by differences inleverage across firms.

KEYWORDS

Default Risk, Distress Risk, Beta Estimation, Value Premium

Cite this paper

Hood III, F. 2016 Leverage, Default Risk, and the Cross-Section of Equity and Firm Returns. Modern Economy, 7, 1610-1639. doi: 10.4236-me.2016.714143.





Autor: Frederick M. Hood III

Fuente: http://www.scirp.org/



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