Leverage, Default Risk, and the Cross-Section of Equity and Firm Returns

Frederick Hood
2013 Social Science Research Network  
I examine the two components of default risk and how they relate to stock returns, size, and book-to-market. High default risk firms do not necessarily have high levels of systematic asset risk. I show that the two components of default risk, asset volatility and leverage, are negatively related. I provide evidence that leverage differences across firms are not reflected in equity betas. Therefore, I construct firm returns using estimates of firm's debt returns. The results indicate that a
more » ... part of the value premium and some of the size premium can be explained by differences in leverage across firms.
doi:10.2139/ssrn.2315766 fatcat:rbu5jtwv5va4hkirzm2jv5fvo4