Browse > Article
http://dx.doi.org/10.13106/jafeb.2021.vol8.no3.0717

The Relationship between Default Risk and Asset Pricing: Empirical Evidence from Pakistan  

KHAN, Usama Ehsan (Applied Economics Research Centre, University of Karachi)
IQBAL, Javed (Institute of Business Administration)
Publication Information
The Journal of Asian Finance, Economics and Business / v.8, no.3, 2021 , pp. 717-729 More about this Journal
Abstract
This paper examines the efficacy of the default risk factor in an emerging market context using the Fama-French five-factor model. Our aim is to test whether the Fama-French five-factor model augmented with a default risk factor improves the predictability of returns of portfolios sorted on the firm's characteristics as well as on industry. The default risk factor is constructed by estimating the probability of default using a hybrid version of dynamic panel probit and artificial neural network (ANN) to proxy default risk. This study also provides evidence on the temporal stability of risk premiums obtained using the Fama-MacBeth approach. Using a sample of 3,806 firm-year observations on non-financial listed companies of Pakistan over 2006-2015 we found that the augmented model performed better when tested across size-investment-default sorted portfolios. The investment factor contains some default-related information, but default risk is independently priced and bears a significantly positive risk premium. The risk premiums are also found temporally stable over the full sample and more recent sample period 2010-2015 as evidence by the Fama-MacBeth regressions. The finding suggests that the default risk factor is not a useless factor and due to mispricing, default risk anomaly prevails in the Pakistani equity market.
Keywords
Asset Pricing; Default Risk; Fama-French Five-Factor Model; Emerging Market;
Citations & Related Records
연도 인용수 순위
  • Reference
1 Chan, K. C., & Chen, N. F. (1991). Structural and return characteristics of small and large firms. The Journal of Finance, 46(4), 1467-1484. https://doi.org/10.1111/j.1540-6261.1991.tb04626.x   DOI
2 Chen, N. F., & Zhang, F. (1998). Risk and return of value stocks. The Journal of Business, 71(4), 501-535. https://doi.org/10.1086/209755   DOI
3 Dichev, I. D. (1998). Is the risk of bankruptcy a systematic risk? The Journal of Finance, 53(3), 1131-1147. https://doi.org/10.1111/0022-1082.00046   DOI
4 Drobetz, W., Sturmer, S., & Zimmermann, H. (2002). Conditional asset pricing in emerging stock markets. The Swiss Journal of Economics and Statistics, 138(4), 507-526. http://www.sjes.ch/papers/2002-IV-11.pdf
5 Fama, E. F., & French, K. R. (1992). The cross-section of expected stock returns. The Journal of Finance, 47(2), 427-465. https://doi.org/10.1111/j.1540-6261.1992.tb04398.x   DOI
6 Fama, E. F., & French, K. R. (1993). Common risk factors in the returns on stocks and bonds. Journal of Financial Economics, 33(1), 3-56.   DOI
7 Fama, E. F., & French, K. R. (1996). Multifactor explanations of asset pricing anomalies. The Journal of Finance, 51(1), 55-84. https://doi.org/10.1111/j.1540-6261.1996.tb05202.x   DOI
8 Fama, E. F., & French, K. R. (1997). Industry costs of equity. Journal of Financial Economics, 43(2), 153-193. https://doi.org/10.1016/S0304-405X(96)00896-3   DOI
9 Fama, E. F., & French, K. R. (2015). A five-factor asset pricing model. Journal of Financial Economics, 116(1), 1-22. https://doi.org/10.1016/j.jfineco.2014.10.010   DOI
10 Fama, E. F., & French, K. R. (2016). Dissecting anomalies with a five-factor model. The Review of Financial Studies, 29(1), 69-103. https://doi.org/10.1093/rfs/hhv043   DOI
11 Gharghori, P., Chan, H., & Faff, R. (2009). Default risk and equity returns: Australian evidence. Pacific-Basin Finance Journal, 17(5), 580-593. https://doi.org/10.1016/j.pacfin.2009.03.001   DOI
12 Fama, E. F., & MacBeth, J. D. (1973). Risk, return, and equilibrium: Empirical tests. Journal of Political Economy, 81(3), 607-636. https://www.journals.uchicago.edu/doi/abs/10.1086/260061   DOI
13 Foye, J. (2018). A comprehensive test of the Fama-French five-factor model in emerging markets. Emerging Markets Review, 37, 199-222. https://doi.org/10.1016/j.ememar.2018.09.002   DOI
14 Gharghori, P., Chan, H., & Faff, R. (2007). Are the FamaFrench factors proxying default risk? Australian Journal of Management, 32(2), 223-249. https://doi.org/10.1177%2F031289620703200204   DOI
15 Gibbons, M. R., Ross, S. A., & Shanken, J. (1989). A test of the efficiency of a given portfolio. Econometrica: Journal of the Econometric Society, 57(5), 1121-1152. https://doi.org/10.2307/1913625   DOI
16 Griffin, J. M., & Lemmon, M. L. (2002). Book-to-market equity, distress risk, and stock returns, The Journal of Finance, 57(5), 2317-2336. https://doi.org/10.1111/1540-6261.00497   DOI
17 Kan, R., & Zhang, C. (1999). Two-pass tests of asset pricing models with useless factors. The Journal of Finance, 54(1), 203-235. https://doi.org/10.1111/0022-1082.00102   DOI
18 Hoang, L. T., Phan, T. T., & Ta, L. N. (2020). Nominal Price Anomaly in Emerging Markets: Risk or Mispricing? Journal of Asian Finance, Economics and Business, 7(9), 125-134. https://doi.org/10.13106/jafeb.2020.vol7.no9.125   DOI
19 Iqbal, J. (2012). Stock market in Pakistan: An overview. Journal of Emerging Market Finance, 11(1), 61-91. https://doi.org/10.1177%2F097265271101100103   DOI
20 Iqbal, J., Brooks, R., & Galagedera, D. U. (2010). Testing conditional asset pricing models: An emerging market perspective. Journal of International Money and Finance, 29(5), 897-918. https://doi.org/10.1016/j.jimonfin.2009.12.004   DOI
21 Khan, U. E., Iqbal, J., & Iftikhar, F. (2020). The Riskiness of Risk Models: Assessment of Bankruptcy Risk of Non-Financial Sector of Pakistan, Business & Economic Review, 12(2). http://dx.doi.org/10.22547/BER/12.2.3   DOI
22 Lo, A. W., & MacKinlay, A. C. (1990). Data-snooping biases in tests of financial asset pricing models. The Review of Financial Studies, 3(3), 431-467. https://doi.org/10.1093/rfs/3.3.431   DOI
23 Modigliani, F., & Miller, M. H. (1958). The cost of capital, corporation finance and the theory of investment. The American Economic Review, 48(3), 261-297. https://www.jstor.org/stable/1809766
24 Shleifer, A., & Vishny, R. W. (1997). A survey of corporate governance. The Journal of Finance, 52(2), 737-783. https://doi.org/10.1111/j.1540-6261.1997.tb04820.x   DOI
25 Nurhayati, I., & Endri, E. (2020). A New Measure of Asset Pricing: Friction-Adjusted Three-Factor Model. Journal of Asian Finance, Economics and Business, 7(12), 605-613. https://doi.org/10.13106/jafeb.2020.vol7.no12.605   DOI
26 Ohlson, J. A. (1980). Financial ratios and the probabilistic prediction of bankruptcy. Journal of Accounting Research, 18(1), 109-131. https://doi.org/10.2307/2490395   DOI
27 Pojanavatee, S. (2020). Tests of a Four-Factor Asset Pricing Model: The Stock Exchange of Thailand. Journal of Asian Finance, Economics and Business, 7(9), 117-123. https://doi.org/10.13106/jafeb.2020.vol7.no9.117   DOI
28 Vassalou, M., & Xing, Y. (2004). Default risk in equity returns. The Journal of Finance, 59(2), 831-868. https://doi.org/10.1111/j.1540-6261.2004.00650.x   DOI
29 Altman, E. I. (1968). Financial ratios, discriminant analysis and the prediction of corporate bankruptcy. The Journal of Finance, 23(4), 589-609. https://doi.org/10.2307/2978933   DOI
30 Agarwal, V., & Taffler, R. (2008). Does financial distress risk drive the momentum anomaly? Financial Management, 37(3), 461-484. https://www.jstor.org/stable/20486664   DOI
31 Altman, E. I., & Rijken, H. A. (2011). Toward a bottom-up approach to assessing sovereign default risk. Journal of Applied Corporate Finance, 23(1), 20-31. https://doi.org/10.1111/j.1745-6622.2011.00311.x   DOI
32 Ang, A., Liu, J., & Schwarz, K. (2010). Using stocks or portfolios in tests of factor models. Journal of Financial and Quantitative Analysis, 1-42.
33 Asis, G., Chari, A., & Haas, A., 2020. In search of distress risk in emerging markets. NBER Working Paper 27213. https://doi.org/10.0.13.58/w27213   DOI
34 Avramov, D., & Zhou, G. (2010). Bayesian portfolio analysis. Annual Review of Financial Economics, 2(1), 25-47. https://doi.org/10.1146/annurev-financial-120209-133947   DOI
35 Bauer, J. (2012). Bankruptcy risk prediction and pricing: Unravelling the negative distress risk premium. Bedford, UK: Doctoral dissertation, Cranfield University. https://dspace.lib.cranfield.ac.uk/handle/1826/7313
36 Campbell, J. Y., Hilscher, J., & Szilagyi, J. (2008). In search of distress risk. The Journal of Finance, 63(6), 2899-2939. https://doi.org/10.1111/j.1540-6261.2008.01416.x   DOI
37 Chan, H., Faff, R., & Kofman, P. (2011). Is default risk priced in Australian equity? Exploring the role of the business cycle. Australian Journal of Management, 36(2), 217-246. https://doi.org/10.1177%2F0312896211407528   DOI