Mind the Tail, or Risk to Fail
52 Pages Posted: 4 Oct 2016 Last revised: 19 Feb 2019
Date Written: January 2019
In this study we hypothesise that more frequent extreme negative daily equity returns result in higher tail risk, and this subsequently increases firms’ likelihood of entering financial distress. Specifically, we investigate the role of Value-at-risk and Expected Shortfall in aggravating firms’ likelihood of experiencing financial distress. Our results show that longer horizon (three- and five-year) tail risk measures contributes positively toward firms’ likelihood of experiencing financial distress. Additionally, considering the declining number of bankruptcy filings, and increasing out-of-court negotiations and debt reorganisations, we argue in favour of penalising firms for becoming sufficiently close to bankruptcy that they have questionable going-concern status. Thus, we propose a definition of financial distress contingent upon firms’ earnings, financial expenses, market value and operating cash flow.
Keywords: downside risk, value at risk, tail risk, bankruptcy, financial distress
JEL Classification: G33, C53
Suggested Citation: Suggested Citation