Understanding the Behavior of Distressed Stocks

67 Pages Posted: 13 Jun 2017 Last revised: 11 Aug 2020

See all articles by Yasser Boualam

Yasser Boualam

University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School

Joao F. Gomes

The Wharton School

Colin Ward

University of Minnesota - Carlson School of Management

Date Written: January 16, 2020

Abstract

We construct an asset pricing model with explicit default to develop a risk-based source of the distress anomaly. We show that distress produces sharply countercyclical betas leading to biased estimates of risk premia and alphas. This effect is amplified when earnings growth is mean-reverting, so that distressed stocks also have high expected future earnings. This bias can account for between 39 and 76 percent of the distress anomaly in a calibrated economy that replicates the key characteristics of these stocks.

Keywords: Distress Anomaly, Asset Pricing, Endogenous Default, Nonlinear Estimation

JEL Classification: G11, G12

Suggested Citation

Boualam, Yasser and Gomes, João F. and Ward, Colin, Understanding the Behavior of Distressed Stocks (January 16, 2020). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=2985004 or http://dx.doi.org/10.2139/ssrn.2985004

Yasser Boualam

University of North Carolina (UNC) at Chapel Hill - Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States

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

João F. Gomes

The Wharton School ( email )

2329 SH-DH
3620 Locust Walk
Philadelphia, PA 19104
United States
215-898-3666 (Phone)
215-898-6200 (Fax)

HOME PAGE: http://fnce.wharton.upenn.edu/profile/gomesj/

Colin Ward (Contact Author)

University of Minnesota - Carlson School of Management ( email )

Carlson School of Management
321 19th Avenue South
Minneapolis, MN 55455
United States

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