Revisiting the Relation between Distress Risk and Stock Returns
35 Pages Posted: 31 Jul 2008 Last revised: 1 Feb 2010
Date Written: January 19, 2010
Several prior studies use reduced-form models of bankruptcy or default risk to proxy for corporate distress and find evidence of a significant negative relation between distress risk and average returns. This paper introduces a substantially broader measure of firm failure risk, the probability a firm is delisted from a major U.S. stock exchange for performance reasons, and revisits the pricing of distressed stocks. In contrast to the prior literature, I find distressed stocks earn higher average returns than those with a low probability of failure. Moreover, distress risk is significantly priced in the cross section. While the size and value effects remain robust to controlling for failure risk, I find evidence that SMB and HML contain some distress-related information.
Keywords: Distress risk, performance delisting, hazard model, value effect, size effect, financial distress
JEL Classification: G11, G12, G33
Suggested Citation: Suggested Citation