Is default risk priced? Empirical evidence in the presence of fat tails

Purpose: To determine whether default risk is priced in the presence of fat tails. Originality: Modelling asset returns using a Multivariate t distribution. Key literature / theoretical perspective: Default Likelihood Indicator developed by Vassalou and Xing (2004) and multivariate t research by Kan and Zhou (2006). Design/methodology/approach: Empirical study of monthly US stock returns (1978 – 2007) using portfolios and control variables. Findings: Modelling returns, of distressed stocks, using a multivariate t in place of multivariate normal can have a substantial impact on the associated economic inferences. Practical and Social implications: Asset pricing and portfolio decision-making.