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Investing in Chapter 11 Stocks: Trading, Value, and Performance


Zhaodong Zhong


Rutgers University

Yuanzhi Li


Temple University - Department of Finance

August 8, 2012

EFA 2009 Bergen Meetings Paper

Abstract:     
This paper addresses several questions about Chapter 11 stocks regarding their trading environment, fundamental value, and performance. First, we show that there exists active trading for Chapter 11 stocks throughout the duration of the bankruptcy process. Second, applying option theory to the valuation of bankrupt equity, we find that equity value of bankrupt firm after filing is positively related to asset value, asset volatility, risk-free rate, and expected duration, and it is negatively related to liabilities. Furthermore, similar to the payoff of out-of-money calls, the return correlation between bankrupt stocks and their matching samples exhibits strong non-linearity: significantly positive when the matching sample performs well and zero otherwise. Third, we find that investing in Chapter 11 stocks incurs large losses. Consistent with the theories of heterogeneous beliefs and limits-to-arbitrage, stocks with higher levels of information uncertainty and more binding short-sale constraints experience more negative returns during the Chapter 11 process.

Number of Pages in PDF File: 48

Keywords: bankruptcy, option pricing, heterogeneous beliefs, limits to arbitrage

JEL Classification: G33, G12, G14

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Date posted: February 17, 2009 ; Last revised: April 21, 2014

Suggested Citation

Zhong, Zhaodong and Li, Yuanzhi, Investing in Chapter 11 Stocks: Trading, Value, and Performance (August 8, 2012). EFA 2009 Bergen Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1343765 or http://dx.doi.org/10.2139/ssrn.1343765

Contact Information

Zhaodong Zhong (Contact Author)
Rutgers University ( email )
Department of Finance, Rutgers Business School
94 Rockafeller Road
Piscataway, NJ 08854-8054
United States
Yuanzhi Li
Temple University - Department of Finance ( email )
Fox School of Business and Management
Philadelphia, PA 19122
United States

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