Title: Credit rating downgrade risk on equity returns
Authors: Periklis Brakatsoulas - Charles University, Faculty of Social Sciences (Czech Republic) [presenting]
Abstract: An asset pricing model is developed to capture credit rating downgrade risk and a new methodology is suggested to generate firm-level downgrade probabilities. Using credit transition matrices and rating histories from US issuers, we provide empirical evidence for a statistically significant positive downgrade risk premium. Stocks at a higher risk of failure tend to deliver higher returns. The performance of the model remains robust across several panel data estimation methods. Panel Granger causality test results further indicate a Granger-causal relationship from credit rating transition probabilities to excess returns. The basis for further development and empirical validation of Fama-French-type models under financial distress is provided.