Understanding the Behavior of Distressed Stocks

44 Pages Posted: 13 Jun 2017 Last revised: 22 Dec 2017

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: December 21, 2017

Abstract

This paper argues that the seemingly lower returns on distressed stocks are partly the result of estimation bias and proposes an exact theoretical correction that can be applied in practice. The bias emerges because financial distress induces sharply countercyclical nonlinear movements in betas that are not well captured by standard linear factor pricing models. We show that this can lead to sizably negative abnormal excess returns. After implementing our proposed correction we see much less evidence of underperformance for portfolios of distressed stocks in the data.

Keywords: Distress Anomaly, Asset Pricing, Bias, Nonlinear Estimation

JEL Classification: G11, G12

Suggested Citation

Boualam, Yasser and Gomes, Joao F. and Ward, Colin, Understanding the Behavior of Distressed Stocks (December 21, 2017). 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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