AN EMPIRICAL INVESTIGATION ON THE RELATIONSHIP BETWEEN RISK OF BANKRUPTCY AND STOCK RETURN

The main objective of the paper is to find out whether bankruptcy risk is a systematic risk. In particular, we investigate the contribution of size, book- to-market, excess market returns and bankruptcy probability in explaining returns. We allocate stocks into portfolios according to the probability of bankruptcy from the hazard model. Results show that bankruptcy risk is not a systematic risk. The results consistently show that excess market returns and size have strong power to explain returns in the UK for the period from 1988 to 1997. Book-to-market and bankruptcy risk only matter in portfolios with higher probability of bankruptcy.