Credit risk and stock return - An investigation of the credit risk premium

Abstract: Several researchers have investigated the relationship between credit risk and stock returns, but their findings are ambiguous. While some have found the anomalous relationship that investors pay a negative risk premium when investing in high credit risk stocks, others have presented opposing results. This non-consensus and intriguing results motivated us to further investigate this relationship by examining the returns of approximately 8000 stocks in the U.S. during the period 2007-2017. To find if there is an anomalous relationship we used a multi-factor model incorporating market excess return and the firm-specific factors; size, value and credit ratings. Our results indicate that credit ratings can be used to explain stock return and that there is a positive relationship between the credit risk and stock return.