Default Risk And Equity Returns: A Comparison Of the Bank-Based German And The U.S. Financial System

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Executive Summary

The authors address the question whether the impact of default risk on equity returns depends on the financial system firms operate in. They compare results from asset pricing tests for the German and the U.S. stock markets, where Germany is the prime-example for a bank-based financial system. They find that a higher firm default risk systematically leads to lower returns in both capital markets. This contradicts results for the U.S. by Vassalou/Xing (2004), but they show that their default risk factor loses its explanatory power if one includes a default risk factor measured as a factor mimicking portfolio, as they do.

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