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Volume 32 Number 2 December 2007 |
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Are the Fama-French Factors Proxying Default Risk? |
| Philip Gharghori Howard Chan Robert Faff |
Abstract |
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In this paper we investigate the contention that the Fama-French (1993) model's
ability to explain cross-sectional variation in equity returns occurs because the Fama-French factors, SMB and HML, are proxying for default risk. To assess the
default risk hypothesis, we augment the CAPM and the Fama-French model with a default factor and run system regressions of the default enhanced models using the GMM approach. Our key findings are that: 1) default risk is not priced in equity returns; and, 2) the Fama-French factors are not proxying for default risk. Although our findings suggest that SMB and HML are not proxying for default risk,
our analysis indicates that the Fama-French factors are capturing some form of
priced risk. However, what type of risk the Fama-French factors are capturing remains an open question.
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Keywords |
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FAMA-FRENCH MODEL; DEFAULT RISK; ASSET PRICING.
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Contact DetailsPhilip GharghoriRobert Faff Department of Accounting and Finance, Monash University, PO Box 11E, VIC 3800. Howard Chan Department of Finance, University of Melbourne, VIC 3010 Email: robert.faff@buseco.monash.edu.au |
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