University of Isfahan Journal of Asset Management and Financing 2383-1189 7 3 2019 09 23 Explaining the Default Risk Premium Anomaly Using Two Beta Model Explaining the Default Risk Premium Anomaly Using Two Beta Model 45 58 22823 10.22108/amf.2018.91613.0 FA Daryoosh Forooghi Associate Professor of Accounting Department, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran 0000-0002-7164-6728 Hadi Amiri Assistant Professor of Economic Department, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran Ebrahim Sadreddin Ph. D. Student of Accounting Department, Faculty of Administrative Sciences and Economics, University of Isfahan, Isfahan, Iran Journal Article 2016 04 14 <strong>Objective: </strong>Given some failures of the Capital Asset Pricing Model in explaining the default risk anomaly, some researchers have claimed the two-beta model, established by Campbell and Vulteenaho (2004), is functionally able to explain this peculiarity. Originated primarily from CAPM, two-beta model decomposes the market beta to the discount-rate beta and the cash-flow beta. In other words, the two beta model decomposes the systematic risk to the discount-rate and cash-flow risk. <br /><strong>Method: </strong>In an attempt to test the ability of the model to explain the anomaly in the Tehran Sthock Exchange, we firstly ranked firms based on their default risks, measured by Ohlson’s (1980) model, and then employed the two-beta model to decompose the market beta to discount-rate beta and cash-flow beta. We, ultimately, applied a simple regression model to extract the discount-rate risk premium and cash-flow risk premium. <br /><strong>Results: </strong>Our results reveal that as the default risk increases, the discount-rate beta increases and the cash-flow beta decreases. Furthermore, the cash-flow risk premium is significantly more than the discount-rate risk premium. Therefore, the two-beta model can explain the anomalous default risk existing in the Tehran Exchange Security. <strong>Objective: </strong>Given some failures of the Capital Asset Pricing Model in explaining the default risk anomaly, some researchers have claimed the two-beta model, established by Campbell and Vulteenaho (2004), is functionally able to explain this peculiarity. Originated primarily from CAPM, two-beta model decomposes the market beta to the discount-rate beta and the cash-flow beta. In other words, the two beta model decomposes the systematic risk to the discount-rate and cash-flow risk. <br /><strong>Method: </strong>In an attempt to test the ability of the model to explain the anomaly in the Tehran Sthock Exchange, we firstly ranked firms based on their default risks, measured by Ohlson’s (1980) model, and then employed the two-beta model to decompose the market beta to discount-rate beta and cash-flow beta. We, ultimately, applied a simple regression model to extract the discount-rate risk premium and cash-flow risk premium. <br /><strong>Results: </strong>Our results reveal that as the default risk increases, the discount-rate beta increases and the cash-flow beta decreases. Furthermore, the cash-flow risk premium is significantly more than the discount-rate risk premium. Therefore, the two-beta model can explain the anomalous default risk existing in the Tehran Exchange Security. https://amf.ui.ac.ir/article_22823_ba89da25744857932201dde7a0f5b474.pdf