Default Risk and Equity Returns: A Comparison of the Bank-Based

We address the question whether the impact of default risk on equity returns depends on the financial system firms operate in. We compare results from asset pricing tests for the German and the U.S. stock markets, where Germany is the prime-example for a bank-based financial system. We find that a higher firm default risk systematically leads to lower returns in both capital markets. This contradicts results for the U.S. by Vassalou/Xing (2004), but we show that their default risk factor looses its explanatory power if one includes a default risk factor measured as a factor mimicking portfolio, as we do.