Default Risk, Idiosyncratic Coskewness and Equity Returns

Charles A. Dice Center Working Paper No. 2009-18

Fisher College of Business Working Paper No. 2009-03-018

50 Pages Posted: 18 Mar 2009 Last revised: 27 Sep 2010

See all articles by Fousseni Chabi-Yo

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management

Jun Yang

Bank of Canada

Multiple version iconThere are 2 versions of this paper

Date Written: March 16, 2010

Abstract

In this paper, we intend to explain an empirical finding that distressed stocks delivered anomalously low returns (Campbell et. al. 2008). We show that in a model where investors have heterogeneous preferences, the expected return of risky assets depends on idiosyncratic coskewness betas, which measure the the co-movement of the individual stock variance and the market return. We find that there is a negative (positive) relation between idiosyncratic coskewness and equity returns when idiosyncratic coskewness betas are positive (negative). We construct two idiosyncratic coskewness factors to capture market-wide effect of idiosyncratic coskewness betas. When we control for these two idiosyncratic coskewness factors, the return difference for distress-sorted portfolios becomes insignificant. High stressed firms earn low returns because high stressed firms have high (low) idiosyncratic coskewness betas when idiosyncratic coskewness betas are positive (negative). Our idiosyncratic coskewness factors can also explain the negative and significant relation between the maximum daily return over the past one month (MAX) and expected stock returns documented in Bali et. al (2009).

Keywords: Financial Distress, Higher Moment Returns, Default Risk, Idiosyncratic Coskewness Beta, Cross-Sectional Equity Returns

JEL Classification: G11, G12, G13, G14, G33

Suggested Citation

Chabi-Yo, Fousseni and Yang, Jun, Default Risk, Idiosyncratic Coskewness and Equity Returns (March 16, 2010). Charles A. Dice Center Working Paper No. 2009-18 , Fisher College of Business Working Paper No. 2009-03-018, Available at SSRN: https://ssrn.com/abstract=1363767 or http://dx.doi.org/10.2139/ssrn.1363767

Fousseni Chabi-Yo (Contact Author)

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

Jun Yang

Bank of Canada ( email )

234 Wellington Street
Ontario, Ottawa K1A 0G9
Canada

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