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- Title
THE EFFECTS OF DEFAULT RISK ON THE MARKET MODEL.
- Authors
Carpenter, Michael D.; I. Keong Chew
- Abstract
The purpose of this paper is to examine empirically whether the Sharpe's single index market model (SIMM) parameters vary significantly when the bond ratings of the firm are changed. Several studies show a relationship between stock betas and bond ratings. Scholars C.J. Schwendiman and G.E. Pinches find that "common stock betas in the top three categories are significantly different from common stock betas for firms issuing noninvestment grade bonds." Scholars R.S. Kaplan and G. Urwitz classify about two-thirds of a holdout sample of newly issued bonds correctly with a model where one of the explanatory variables is stock beta. Scholars D. Galai and R.W. Masulis use the option pricing model to provide a theoretical basis for a relationship between bond ratings and stock beta. The present study extends these studies by investigating the effects of bond rating reclassification on the stationarity of the SIMM. Some major findings of this study are the SIMM of a company's stock tends to be affected significantly by an upgrading, but not by a downgrading, of the company's bonds, bond rating changes do not seem to change the intercept term of the SIMM and an increase in a stock's beta tends to follow bond upgrading and a decrease, bond downgrading.
- Publication
Journal of Financial Research, 1983, Vol 6, Issue 3, p223
- ISSN
0270-2592
- Publication type
Academic Journal
- DOI
10.1111/j.1475-6803.1983.tb00331.x