The Effect of Credit Risk on Stock Returns

This paper investigates the effect of credit risk on the return of stocks. We construct a systematic factor in relation to credit risk using the credit spreads of individual firms measured from the Merton (1974) model. This enables us to include firms without credit spreads or ratings information in our analysis so that we are free of sample selection bias. The credit factor captures a systematic risk in the Korean stock market, which the standard Fama-French three factors (market, size and value) and the momentum factor cannot fully explain