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Omitted debt risk, financial distress and the cross-section of expected equity returns

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Omitted debt risk, financial distress and the cross-section of expected equity returns. / Aretz, K; Shackleton, M B.
In: Journal of Banking and Finance, Vol. 35, No. 5, 2011, p. 1213-1227.

Research output: Contribution to Journal/MagazineJournal articlepeer-review

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Aretz K, Shackleton MB. Omitted debt risk, financial distress and the cross-section of expected equity returns. Journal of Banking and Finance. 2011;35(5):1213-1227. doi: 10.1016/j.jbankfin.2010.10.018

Author

Aretz, K ; Shackleton, M B. / Omitted debt risk, financial distress and the cross-section of expected equity returns. In: Journal of Banking and Finance. 2011 ; Vol. 35, No. 5. pp. 1213-1227.

Bibtex

@article{1200467e2b6342d0936066c7a3a2868b,
title = "Omitted debt risk, financial distress and the cross-section of expected equity returns",
abstract = "The study of Ferguson and Shockley (2003) shows that, if the Merton (1974) model can reflect reality, the omission of debt claims from the market portfolio proxy may explain the poor pricing ability of the CAPM in empirical tests. We critically re-assess this argument by first reviewing existing, but also new avenues through which the Merton (1974) model can point to a systematic bias in market beta estimates. However, we also show that some avenues are diversifiable, and that they all rely on excessive economy-wide default risk to create a non-negligible bias. We then use the Merton (1974) model to proxy for the total debt portfolio, but find that its application in empirical tests cannot improve pricing performance. We conclude that there are (so far) no valid theoretical reasons to believe that omitted debt claims undermine CAPM tests.",
author = "K Aretz and Shackleton, {M B}",
year = "2011",
doi = "10.1016/j.jbankfin.2010.10.018",
language = "English",
volume = "35",
pages = "1213--1227",
journal = "Journal of Banking and Finance",
issn = "0378-4266",
publisher = "Elsevier",
number = "5",

}

RIS

TY - JOUR

T1 - Omitted debt risk, financial distress and the cross-section of expected equity returns

AU - Aretz, K

AU - Shackleton, M B

PY - 2011

Y1 - 2011

N2 - The study of Ferguson and Shockley (2003) shows that, if the Merton (1974) model can reflect reality, the omission of debt claims from the market portfolio proxy may explain the poor pricing ability of the CAPM in empirical tests. We critically re-assess this argument by first reviewing existing, but also new avenues through which the Merton (1974) model can point to a systematic bias in market beta estimates. However, we also show that some avenues are diversifiable, and that they all rely on excessive economy-wide default risk to create a non-negligible bias. We then use the Merton (1974) model to proxy for the total debt portfolio, but find that its application in empirical tests cannot improve pricing performance. We conclude that there are (so far) no valid theoretical reasons to believe that omitted debt claims undermine CAPM tests.

AB - The study of Ferguson and Shockley (2003) shows that, if the Merton (1974) model can reflect reality, the omission of debt claims from the market portfolio proxy may explain the poor pricing ability of the CAPM in empirical tests. We critically re-assess this argument by first reviewing existing, but also new avenues through which the Merton (1974) model can point to a systematic bias in market beta estimates. However, we also show that some avenues are diversifiable, and that they all rely on excessive economy-wide default risk to create a non-negligible bias. We then use the Merton (1974) model to proxy for the total debt portfolio, but find that its application in empirical tests cannot improve pricing performance. We conclude that there are (so far) no valid theoretical reasons to believe that omitted debt claims undermine CAPM tests.

U2 - 10.1016/j.jbankfin.2010.10.018

DO - 10.1016/j.jbankfin.2010.10.018

M3 - Journal article

VL - 35

SP - 1213

EP - 1227

JO - Journal of Banking and Finance

JF - Journal of Banking and Finance

SN - 0378-4266

IS - 5

ER -