Abstract:
Changes in credit risk may arise when either the value or the risk of corporate
assets changes. Changes in the equity value associated with the changes in the
asset value and changes in asset risk can be characterized into potentially countervailing
direct and indirect effects. The indirect effect of risk on equity value is a
function of factors that affect the debt value of including leverage, asset value, and
asset risk. This study examines whether the equity value reflects the profits and
losses associated with the changes in the debt value consistent with the predictions
of Merton [21]. The insurance companies listed in the Stock Exchange during
2010-2015 were selected to test the desired hypotheses. It has been found that the
stock returns are negatively related to the increase in credit risk as reflected in the
changes of estimated bond ratings. More importantly for the research question, it
has been realized that the relationship between risk changes and equity returns is
negative when the leverage is higher.
Machine summary:
It has been found that the stock returns are negatively related to the increase in credit risk as reflected in the changes of estimated bond ratings.
Research question has been presented on the application of fair value accounting for the Liabilities along with recognizing the elements regarded as the anomalous effects originated from the credit risk on the value variations of stakeholders.
When the market equity return rate in accordance with new level of risk is different from the rate determined at the beginning of con- tract, the debt value is changed.
Understanding how the variations of credit risk affect the debt and equity values is crucial in the discussion of fair value accounting application for the Liabilities.
With regard to credit risk consisted of common elements affecting the equity and debt return, Vassalou and Xing found out that a huge part of default risk is systematic and thus, it is priced by the means of equity value [26].
Barth studied the impact of equity value which is reflective of returns and losses in relation to the debt value changes and concluded that the equity re- turn is negatively related to the increased credit risk which may be reflected by the changes in the ratings of savings bonds and the relationship between the changes of risk and equity return is not neg- ative if the leverage is higher [8].