Essays in Pricing of Credit Risk in Bond and Equity Markets.

Abstract

This work consists of two essays that investigate the pricing of credit risk in the equity and bond markets. The first essay, “Is there a Distress Risk Anomaly? Bond Spread as a Proxy for Default Risk,” investigates the pricing of default risk in the cross section of equity returns. The contribution of this paper to the literature is three-fold. First, the paper shows that the distress risk anomaly is an amalgamation of other anomalies and return relationships previously documented in the literature. Second, this is the first paper to use corporate bond spreads to measure the ex-ante probability of default risk. Third, contrary to previous findings, we show that default risk is not priced negatively in the cross section of equity returns. The second essay, “Corporate Reputation and Cost of Debt”, investigates the role a firm’s reputation plays in determining its cost of debt. We measure a company’s reputation using the annual ranking of “Most Admired Companies” published by Fortune magazine, which surveys industry experts on perceptions of firm quality along eight attributes. After controlling for credit risk and other known determinants of credit spreads, we find a robust inverse relationship between a firm’s reputation as measured by the Fortune survey and the credit spread on its bonds. We also find this effect to be greater for firms that are subject to greater information asymmetry. By explicitly accounting for an intangible element of credit risk, we substantially improve upon the existing literature which, relying on more tangible factors, concludes that a large component of credit spread variation remains unexplained. We also show that the Fortune reputation measure is a good ex ante predictor of corporate failure, improving upon standard measures used in the literature.Ph.D.Business AdministrationUniversity of Michigan, Horace H. Rackham School of Graduate Studieshttp://deepblue.lib.umich.edu/bitstream/2027.42/89806/1/yildizha_1.pd