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https://ssrn.com/abstract=1448797
 
 

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Tracking Down Distress Risk


Nishad Kapadia


Tulane University - A.B. Freeman School of Business

June 14, 2010


Abstract:     
This paper shows that exposure to aggregate distress risk is the underlying source of the premiums for the Fama-French size (SMB) and value (HML) factors. Using a unique dataset of aggregate business failures of both private and public firms from 1926 to 1997, I build portfolios that track news about future firm failures. These tracking portfolios optimally hedge aggregate distress risk and earn a CAPM alpha of approximately -4% a year. Both HML and SMB predict changes in future failure rates. Small stocks have lower returns than large stocks and value stocks have lower returns than growth stocks when the market expects an increase in future failure rates. Finally, a two-factor model with the market and the tracking portfolio for aggregate distress as factors does as well as the Fama-French three-factor model in pricing the 25 size and book-to-market sorted portfolios and 30 industry sorted portfolios.

Number of Pages in PDF File: 44

Keywords: distress risk, value, growth, bankruptcy

JEL Classification: G11, G12, G32, G33


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Date posted: August 15, 2009 ; Last revised: June 15, 2010

Suggested Citation

Kapadia, Nishad, Tracking Down Distress Risk (June 14, 2010). Available at SSRN: https://ssrn.com/abstract=1448797 or http://dx.doi.org/10.2139/ssrn.1448797

Contact Information

Nishad Kapadia (Contact Author)
Tulane University - A.B. Freeman School of Business ( email )
A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States
504-314-7454 (Phone)
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