Working Papers, Department of Economics, Lund University
Stock Return Expectations in the Credit Market
Abstract: In this paper we compute long-term stock return
expectations (across the business cycle) for individual firms using
information backed out from the credit derivatives market. Our methodology
builds on previous theoretical results in the literature on stock return
expectations and, empirically, we demonstrate a close relationship between
credit-implied stock return expectations and future realized stock returns.
We also find stock portfolios selected based on credit-implied stock return
forecasts to beat equally- and value-weighted portfolios of the same stocks
out-of-sample. Contrary to many other studies, our expectations/predictions
are made at the individual stock level rather than at the portfolio level,
and no parameter estimations using historical stock price- or credit spread
observations are needed.
Keywords: stock market; credit default swap; implied volatility; CreditGrades; return expectations; (follow links to similar papers)
JEL-Codes: G01; G10; (follow links to similar papers)
29 pages, October 12, 2016
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