Small Growth and Distress Returns: Two Sides of the Same Coin?

2015 World Congress of the Econometric Society

1st Place 2015 CQAsia Academic Competition, Hong Kong

2014 SAFE Asset Pricing Workshop

Best Paper on Valuation, 2014 26th Annual Meetings Northern Finance Association, Ottawa

2014 International Conference on Asia-Pacific Financial Markets

53 Pages Posted: 21 Nov 2013 Last revised: 23 Feb 2016

See all articles by Harjoat Singh Bhamra

Harjoat Singh Bhamra

Imperial College Business School

Kyung Hwan Shim

University of New South Wales (UNSW)

Multiple version iconThere are 2 versions of this paper

Date Written: February 23, 2016

Abstract

We propose a unified explanation for two seemingly disparate empirical findings: the negative abnormal returns of distressed stocks, and of small growth stocks. Based on a counterintuitive result relating option prices to jump risk (Merton 76), we show via an investment valuation model that higher idiosyncratic risks of sudden corporate failure simultaneously generate lower expected returns and higher valuation ratios among smaller firms. Consistent with the model, high failure risk traits characterize small growth stocks, and a failure risk factor subsumes small growth returns while explaining several asset pricing anomalies.

Keywords: Distress, size, book-to-market, small, growth, glamor, stocks, failure risk, default risk, anomalies, cross section of stock returns, asset pricing, real options, growth options, mixed jump-diffusion process

JEL Classification: G10, G12, G13, G19, G30, G31, G32, D21, D92

Suggested Citation

Bhamra, Harjoat Singh and Shim, Kyung Hwan, Small Growth and Distress Returns: Two Sides of the Same Coin? (February 23, 2016). 2015 World Congress of the Econometric Society; 1st Place 2015 CQAsia Academic Competition, Hong Kong; 2014 SAFE Asset Pricing Workshop; Best Paper on Valuation, 2014 26th Annual Meetings Northern Finance Association, Ottawa; 2014 International Conference on Asia-Pacific Financial Markets. Available at SSRN: https://ssrn.com/abstract=2348433 or http://dx.doi.org/10.2139/ssrn.2348433

Harjoat Singh Bhamra

Imperial College Business School ( email )

Tanaka Building
Exhibition Rd
London, SW7 2AZ
United Kingdom

HOME PAGE: http://www.harjoatbhamra.com

Kyung Hwan Shim (Contact Author)

University of New South Wales (UNSW) ( email )

306 Level 3 ASB
UNSW Kensington Campus
UNSW Sydney, NSW 2052
Australia
61293855852 (Phone)

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