The Cross-Section of Expected Returns on Defaultable Assets

2017 ◽  
Vol 25 (4) ◽  
pp. 479-508
Author(s):  
Jungmu Kim ◽  
Yuen Jung Park
Keyword(s):  
Risk Factors ◽  
Term Structure ◽  
Risk Premium ◽  
Default Risk ◽  
Stock Price ◽  
Estimation Method ◽  
Credit Default Swap ◽  
Expected Returns ◽  
Accounting Data ◽  
Distress Risk

This study examines the model regarding the relation between the expected returns of defaultable asset and default risk factors utilizing CDS (credit default swap). While the previous study estimates the expected returns of CDS using stock price and accounting data, this study introduces new estimation method using CDS term structure. Two factors incorporating market-wide distress risk and recovery risk are considered as the default risk factors. The results of analyzing the Korean corporate CDS market over the sample period from September 2009 to December 2016 are as follows. First, for the expected returns of CDS, there exists the negative risk premium related to market-wide distress risk covariance. Second, the finding of this negative risk premium is robust even after the market risk factors and liquidity factor are controlled for. Third, the negative premium related to recovery risk is observed but it is not statistically significant. These results imply that the investors consider the market-wide distress risk covariance as the main risk factor when pricing the Korean corporate CDSs and they require the reward taking risk as they invest CDS with the lower distress risk covariance. Therefore, our empirical results support the model that the covariance part between individual firm's distress risk and market-wide default risk changes is not diversifiable and thus the investors require the premium for this non-diversifiable risk.

How to estimate expected credit losses – ECL – for provisioning under IFRS 9

2021 ◽  
Vol ahead-of-print (ahead-of-print) ◽  
Author(s):  
Mariya Gubareva
Keyword(s):  
Risk Premium ◽  
Default Risk ◽  
Financial Regulation ◽  
Credit Default Swap ◽  
High Yield ◽  
Expected Loss ◽  
Content Type ◽  
Term Structures ◽  
Ifrs 9 ◽  
Investment Grade

PurposeThis paper provides an objective approach based on available market information capable of reducing subjectivity, inherently present in the process of expected loss provisioning under the IFRS 9.Design/methodology/approachThis paper develops the two-step methodology. Calibrating the Credit Default Swap (CDS)-implied default probabilities to the through-the-cycle default frequencies provides average weights of default component in the spread for each forward term. Then, the impairment provisions are calculated for a sample of investment grade and high yield obligors by distilling their pure default-risk term-structures from the respective term-structures of spreads. This research demonstrates how to estimate credit impairment allowances compliant with IFRS 9 framework.FindingsThis study finds that for both investment grade and high yield exposures, the weights of default component in the credit spreads always remain inferior to 33%. The research's outcomes contrast with several previous results stating that the default risk premium accounts at least for 40% of CDS spreads. The proposed methodology is applied to calculate IFRS 9 compliant provisions for a sample of investment grade and high yield obligors.Research limitations/implicationsMany issuers are not covered by individual Bloomberg valuation curves. However, the way to overcome this limitation is proposed.Practical implicationsThe proposed approach offers a clue for a better alignment of accounting practices, financial regulation and credit risk management, using expected loss metrics across diverse silos inside organizations. It encourages adopting the proposed methodology, illustrating its application to a set of bond exposures.Originality/valueNo previous research addresses impairment provisioning employing Bloomberg valuation curves. The study fills this gap.

What can increase the default risk in local governments?

2015 ◽  
Vol 83 (2) ◽  
pp. 397-419 ◽  
Author(s):  
Andrés Navarro-Galera ◽  
Juan Lara-Rubio ◽  
Dionisio Buendía-Carrillo ◽  
Salvador Rayo-Cantón
Keyword(s):  
Risk Factors ◽  
Interest Rates ◽  
Risk Premium ◽  
Financial Management ◽  
Local Governments ◽  
Default Risk ◽  
Warning Signs ◽  
Loan Repayment ◽  
Risk Premiums ◽  
Financial Soundness

Concern has been expressed by international organisations and in previous studies about the financial situation of local governments, and the question of debt has been identified as a crucial element in efforts to overcome the current financial crisis. However, the variables that can affect the financial soundness of these governments have not been sufficiently studied, despite their direct relation to the credit risk premium. In this article, we aim to identify risk factors for default by local governments, and provide useful information to municipal financial managers. We conducted an empirical study of 148 Spanish municipalities and analysed data from four years, applying a random effects logistic regression model. Our findings reveal that a lower population density, less dependent population, falling levels of per capita income and the presence of progressive local government are all risk factors for default by local governments. Furthermore, our findings indicate that the general financing structure variable and debt composition and maturity variable do influence the risk of default by local governments. Points for practitioners The findings of this article can provide useful information for managers and politicians responsible for the financial management of local governments, in particular, by enabling them to better understand the risk premiums assigned by banks. Specifically, by identifying the risk factors for default, this article highlights the warning signs of this risk, so that suitable arguments may be expressed in negotiating loan repayment schedules and interest rates, and in designing financial viability and restructuring plans.

scholarly journals Tail Risk and the Cross-Section of Mutual Fund Expected Returns

2018 ◽  
Vol 54 (1) ◽  
pp. 425-447 ◽  
Author(s):  
Nikolaos Karagiannis ◽  
Konstantinos Tolikas
Keyword(s):  
Risk Factors ◽  
Cross Section ◽  
Risk Premium ◽  
Mutual Fund ◽  
Market Risk ◽  
Expected Returns ◽  
Adequate Explanation ◽  
Tail Risk ◽  
Management Fees ◽  
The Cross

We test for the presence of a tail risk premium in the cross-section of mutual fund returns and find that the top tail risk quintile of funds outperforms the bottom by 4.4% per annum. This premium is not simply a reward for market risk, nor do commonly used risk factors offer an adequate explanation. Our findings hold across double-sorted portfolios formed on tail risk and a number of fund characteristics. We also find that funds susceptible to tail risk tend to be small, young, have high management fees, and have managers who do not risk their own capital.

THE "FIRM-SPECIFIC RETURN VARIATION": A MEASURE OF PRICE INFORMATIVENESS OR INFORMATION ASYMMETRY?

2005 ◽  
Vol 01 (01) ◽  
pp. 0550004
Author(s):  
RADU BURLACU ◽  
PATRICE FONTAINE ◽  
SONIA JIMENEZ-GARCÈS
Keyword(s):  
Stock Returns ◽  
Risk Premium ◽  
Stock Price ◽  
Rational Expectations ◽  
Expected Returns ◽  
Excess Returns ◽  
Price Informativeness ◽  
Common Stocks ◽  
Good Proxy ◽  
Stock Price Informativeness

This paper investigates the relevancy of the "Firm-Specific Return Variation" (FSRV) as a measure of stock price informativeness. For this purpose, we study the link between FSRV and stock excess returns on the American market over the period 1986–2001. After controlling for size effects, we find a negative and highly significant impact of FSRV on stock returns. The link between FSRV and stock excess returns is robust to asset pricing models and does not capture systematic, size or "book-to-market" (BM) effects. Based on rational expectations equilibrium (REE) models considering asymmetrically informed investors, we suggest that FSRV is a good proxy for price informativeness. Common stocks with higher specific return variation have lower information-risk premium, thus lower expected returns.

The Variance Swaps based on KOSPI200 Index and the Term Structure of Variance Risk Premium

2013 ◽  
Vol 21 (4) ◽  
pp. 435-463
Author(s):  
Young Ho Eom ◽  
Woon Wook Jang
Keyword(s):  
Risk Factors ◽  
Term Structure ◽  
Risk Premium ◽  
Risk Averse ◽  
Realized Variance ◽  
Over The Counter ◽  
Variance Swaps ◽  
Variance Swap ◽  
Variance Risk Premium ◽  
Variance Risk

This study examines whether the variance risk is a priced risk factor in Korea using the over-the-counter variance swap quotes and realized variance data. We also study the term structure of variance risk premium. The empirical results show that the model with 2 stochastic variance risk factors with jumps in return is required to fit the variance swap and realized variance data. The analyses with the estimated models suggest that the variance risk premium in Korea are highly negative and the size of the premium increase with the maturities, meaning that risk averse investors in Korea are willing to pay a premium to hedge variance risk.

scholarly journals An inhomogeneous semi-Markov model for the term structure of credit risk spreads

2006 ◽  
Vol 38 (01) ◽  
pp. 171-198 ◽  
Author(s):  
Aglaia Vasileiou ◽  
P.-C. G. Vassiliou
Keyword(s):  
Markov Model ◽  
Term Structure ◽  
Real World ◽  
Risk Premium ◽  
Transition Probability ◽  
Estimation Method ◽  
Markov Property ◽  
Stochastic Monotonicity ◽  
The Real ◽  
Functional Relationships

We model the evolution of the credit migration of a corporate bond as an inhomogeneous semi-Markov chain. The valuation of a defaultable bond is done with the use of the forward probability of no default up to maturity time. It is proved that, under the forward probability measure, the semi-Markov property is maintained. We find the functional relationships between the forward transition probability sequences and the real-world probability sequences. The stochastic monotonicity properties of the inhomogeneous semi-Markov model, which play a prominent role in these issues, are studied in detail. Finally, we study the term structure of credit spread, provide an algorithm for the estimation of the forward probabilities of transitions under the risk premium assumptions, and present an estimation method for the real-world probability sequences.

Estimating credit default swap spreads using accounting data, market quotes and credit ratings: the European Banks Case

2015 ◽  
pp. 59-81
Author(s):  
Enrico Laghi ◽  
Michele Di Marcantonio ◽  
Eugenio D'Amico
Keyword(s):  
Stock Price ◽  
Statistical Significance ◽  
Explanatory Power ◽  
Credit Default Swap ◽  
Accounting Data ◽  
Credit Default ◽  
Data Market ◽  
European Banks ◽  
Default Swap ◽  
Swap Spreads

The aim of this paper is to define a model for estimating the theoretical Credit Default Swap spread of European banks considering firms' accounting data, market quotes, official ratings and macroeconomic variables. We detect a significant log-linear relation between Credit Default Swaps spreads and four explanatory variables determined on the basis of the stock price, the financial structure, the equity composition, the incidence of the reserve for loan losses on total loans, the official ratings and macroeconomic indicators of the country of domicile of each company. The empirical results show that for the period from 2008 to 2013 the model has a high statistical significance and a remarkable explanatory power. Our main contribution to the existing literature is the exploration of new determinants of banks' credit risk and the provision of new evidence on the determinants of banks' default risk in the crisis and post-crisis European context. Furthermore, we define a practical model for estimating Credit Default Swap spreads of banks suitable for professional use.

scholarly journals Examination and Modification of Multi-Factor Model in Explaining Stock Excess Return with Hybrid Approach in Empirical Study of Chinese Stock Market

2019 ◽  
Vol 12 (2) ◽  
pp. 91
Author(s):  
Jian Huang ◽  
Huazhang Liu
Keyword(s):  
Risk Factors ◽  
Stock Market ◽  
Empirical Study ◽  
Risk Premium ◽  
Stock Price ◽  
Factor Model ◽  
Five Factor Model ◽  
Hybrid Approach ◽  
Chinese Stock Market ◽  
Cyclical Pattern

To search significant variables which can illustrate the abnormal return of stock price, this research is generally based on the Fama-French five-factor model to develop a multi-factor model. We evaluated the existing factors in the empirical study of Chinese stock market and examined for new factors to extend the model by OLS and ridge regression model. With data from 2007 to 2018, the regression analysis was conducted on 1097 stocks separately in the market with computer simulation based on Python. Moreover, we conducted research on factor cyclical pattern via chi-square test and developed a corresponding trading strategy with trend analysis. For the results, we found that except market risk premium, each industry corresponds differently to the rest of six risk factors. The factor cyclical pattern can be used to predict the direction of seven risk factors and a simple moving average approach based on the relationships between risk factors and each industry was conducted in back-test which suggested that SMB (size premium), CMA (investment growth premium), CRMHL (momentum premium), and AMLH (asset turnover premium) can gain positive return.

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