Default risk, size, and equity returns: Evidence from an emerging stock market

Abstract

Although the relationship among default risk, size, and equity returns is comprehensively investigated in developed stock markets, the analysis is still lacking for Vietnam, an important emerging market in Southeast Asia. The key aim of this research is to examine the relationship among default risk, size, and equity returns in the Vietnamese stock market, and compare the explanatory power of the default-risk factor to the size factor in asset pricing models. We use an option-based model to obtain the proxy of default risk for approximately 360 listed firms in Vietnam. Empirical results show that distance-to-default is negatively related to stock returns. When size is controlled, the default effect exists in different size-ranked portfolios. In asset pricing models, the default-risk factor is more powerful in explaining Vietnamese equity returns compared to the size factor of Fama and French (1993). As a result, default risk is a significant factor in Vietnamese stock returns, consistent with the risk-based point of view.