Abstract
The basic results of Vassalou and Xing (J.Finance 2004) held in the UK over the period 1970-1989: high default risk companies earned a substantial premium, this is concentrated among small stocks, conversely the size effect appears primarily among high default risk stocks and the impact of changes in default risk on returns is short lived. Nevertheless, after 1990 this default risk premium has disappeared, along with the size effect. In addition, even over the 1970-1989 period, tests that go beyond those of Vassalou and Xing suggest important differences between high default risk and small stocks: most importantly, high default risk stocks underperform in risky environments whereas small stocks outperform. Finally, changes in measured default risk seem to be driven mainly by known effects like short-term reversal.
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