Default Risk and Stock Returns in an Emerging Market: Evidence from Pakistan (2006–2023)
Abstract/Description
This study examines whether default risk is priced in Pakistan’s equity market and explores its implications for asset pricing in emerging markets. Using monthly data for 261 non-financial firms listed on PSX from 2006 to 2023, the analysis uses fixed-effects panel regressions with firm-level default probabilities sourced from the NUS Credit Research Initiative. Control variables include firm size, valuation and profitability. This study uses default probability scores directly provided by NUS-CRI for each firm giving it a forward-looking view. The results suggest a statistically significant negative relationship between default risk and stock returns across all forecast horizons. However, the study is limited to firm-level variables and does not involve broader macroeconomic variables. These findings are opposed to traditional models like CAPM and support distress risk puzzle. The results are relevant for investors who look to understand risk mispricing in less efficient capital markets. This shows influence of market inefficiencies, investor behavior and illiquidity in the Pakistani context. The findings show that understanding of risk can help investors trust and build market efficiency in Pakistan.
Keywords
Default Risk, Distress Risk Puzzle, Stock Returns, Pakistan Stock Exchange
Track
Finance
Session Number/Theme
Finance - Session II
Start Date/Time
13-6-2025 4:10 PM
End Date/Time
13-6-2025 5:30 PM
Location
MCC – 12 AMAN CED Building
Recommended Citation
Kumar, S. (2025). Default Risk and Stock Returns in an Emerging Market: Evidence from Pakistan (2006–2023). IBA SBS 4th International Conference 2025. Retrieved from https://ir.iba.edu.pk/sbsic/2025/program/15
COinS
Default Risk and Stock Returns in an Emerging Market: Evidence from Pakistan (2006–2023)
MCC – 12 AMAN CED Building
This study examines whether default risk is priced in Pakistan’s equity market and explores its implications for asset pricing in emerging markets. Using monthly data for 261 non-financial firms listed on PSX from 2006 to 2023, the analysis uses fixed-effects panel regressions with firm-level default probabilities sourced from the NUS Credit Research Initiative. Control variables include firm size, valuation and profitability. This study uses default probability scores directly provided by NUS-CRI for each firm giving it a forward-looking view. The results suggest a statistically significant negative relationship between default risk and stock returns across all forecast horizons. However, the study is limited to firm-level variables and does not involve broader macroeconomic variables. These findings are opposed to traditional models like CAPM and support distress risk puzzle. The results are relevant for investors who look to understand risk mispricing in less efficient capital markets. This shows influence of market inefficiencies, investor behavior and illiquidity in the Pakistani context. The findings show that understanding of risk can help investors trust and build market efficiency in Pakistan.
