Understanding the Behavior of Distressed Stocks

54 Pages Posted: 13 Jun 2017 Last revised: 23 Feb 2019

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: February 21, 2019

Abstract

We construct an asset pricing model with explicit default to develop a risk-based source of the distress anomaly. Distress produces sharply countercyclical betas leading to biased estimates of risk premia and alphas. This is amplified when earnings growth is mean-reverting, so that distressed stocks also have high expected future earnings. The bias is sizable in a calibrated economy that replicates key characteristics of these stocks. We derive an approximate correction for the bias that can be readily applied in practice. Evidence of distressed stocks' underperformance becomes much weaker after this correction, and pricing appears consistent with the CAPM.

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 (February 21, 2019). 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

Register to save articles to
your library

Register

Paper statistics

Downloads
372
Abstract Views
1,945
rank
79,093
PlumX Metrics