The bank default and stock returns in the Vietnamese stock market

Purpose This research investigates the role of the bank default factor in explaining nonfinancial stock returns in Vietnam, an interesting context given the dominance of banks in the capital market. Design/methodology/approach The data sample for the bank default factor includes 27 commercial banks listed on the Vietnamese stock market. The data sample for asset pricing tests includes nearly 600 listed nonfinancial firms. Based on the distance-to-default of Merton (1974), we build the bank risk factor, a macroeconomic variable describing the banking industry's health. We also create the bank mimic factor, an investment strategy composed of long positions on stocks with high bank betas and short positions in stocks with low bank betas. Then, both cross-sectional and time-series asset pricing tests are performed. Findings We observe a significantly positive relationship between average return and bank beta by double-sorting nonfinancial stocks based on their covariance with the market and bank default factors. The bank default factor yields a positive risk premium according to the cross-sectional regressions of Fama and MacBeth (1973). According to the Gibbons et al. (1989) GRS test, the bank mimic factor also exhibits robust explanatory power. The power of these factors remains after three robustness tests: comparison with Fama-French (1993, 2018) multifactor models, the redundancy test and alternative test assets. Originality/value This paper offers some main contributions to market finance. Firstly, our study extends the extant studies investigating the relationship between the banking system's health and equity returns by focusing on Vietnam. In this capital market, bank credit is the dominant force. Secondly, our empirical findings provide compelling evidence of the pivotal role of the banking system's health in driving Vietnamese equity returns, thereby contributing to the asset pricing literature in emerging markets. Including the bank default factor in asset pricing models is crucial for accurately calculating the expected returns and guiding investment decisions.