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The Relationship between Risk of Default and Return on Equity: An Empirical Investigation

Published online by Cambridge University Press:  19 October 2009

Avner Arbel ,
Richard Kolodny  and
Josef Lakonishok
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Extract

The focus of this study is the role of default risk in capital market theory. The impact of default risk on the value of securities has been a major concern of investors and academics alike. Several authors have examined the relationship between bond ratings, the probability of default, and security value [5, 12]. In this context, the ability to avoid or reduce expected bankruptcy costs and thereby increase value has been suggested as a reason for mergers and consolidations [16, 18]. In other studies, models have been developed for predicting ratings [17, 20, 21, 28], for predicting bankruptcy using accounting and other financial variables [1, 6, 7], and for approximating default premiums in the credit markets [22]. Finally a question which has received considerable attention is the effect of bankruptcy on a company's cost of capital. When bankruptcy is possible and there exists a positive bankruptcy transaction cost, it has been argued that there is an optimal capital structure [24, 26].

Type
Proceedings of 1977 Western Finance Association Meeting: Selected Conference Papers
Information
Journal of Financial and Quantitative Analysis , Volume 12 , Issue 4 , November 1977 , pp. 615 - 625
Copyright
Copyright © School of Business Administration, University of Washington 1977

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References

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