On Default Risk, Stock Returns and the Size, Value and Momentum Effects

Abstract

The purpose of this paper is to examine the relationship between default risk, stock returns and the size, value and momentum effects using credit default swap spreads and default probabilities estimated using the Merton model as measures of default risk over the period from January 2003 to June 2021. High default risk stocks have higher average returns than low default risk stocks. The size and value effects are highly related to the documented default risk effect, although they are not identical phenomena. The momentum effect is not related to default risk. A default risk factor contains relevant information for the pricing of assets above and beyond traditional factors.