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Subject: Finance and Investment × Author: Chan, Howard × End date: 2007 × Type: Journal Article × Start date: 2007 ×

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    Are the Fama-French factors proxying default risk?
    Gharghori, P ; Chan, H ; Faff, R (UNIV NEW SOUTH WALES, AUSTR GRAD SCH MANAGEMENT, 2007-12-01)
    In this paper we investigate the contention that the Fama-French (1993) model's ability to explain cross-sectional variation in equity returns occurs because the Fama-French factors, SMB and HML, are proxying for default risk. To assess the default risk hypothesis, we augment the CAPM and the Fama-French model with a default factor and run system regressions of the default enhanced models using the GMM approach. Our key findings are that: 1) default risk is not priced in equity returns; and, 2) the Fama-French factors are not proxying for default risk. Although our findings suggest that SMB and HML are not proxying for default risk, our analysis indicates that the Fama-French factors are capturing some form of priced risk However, what type of risk the Fama-French factors are capturing remains an open question.
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