Financial Distress, Short Sale Constraints, and Mispricing

46 Pages Posted: 18 Nov 2018

See all articles by Dongcheol Kim

Dongcheol Kim

Korea University Business School

Inro Lee

The Bank of Korea

Haejung Na

California State University, Los Angeles

Multiple version iconThere are 2 versions of this paper

Date Written: October 27, 2018


This paper specifically examine how the extent of the distress puzzle differs according to the degree of mispricing and short sale constraints. We find that the distress puzzle observed for overpriced stocks, not for underpriced stocks, becomes insignificant after adjustment for short sale constraints due to an asymmetric pricing effect of short sale constraints only on the short-leg side of distress. However, after adjustment for arbitrage risk, the distress puzzle remains unchanged. These results indicate that the distress puzzle is mainly attributable to short sale constraints, rather than other limits-to-arbitrages such as arbitrage risk, which has a bi-lateral pricing effect on both short-leg and long-leg sides of distress. To mitigate a possible endogeneity problem relation among financial distress, mispricing, and short sale constraints, we measure these variables with different timing.

Keywords: Financial distress puzzle, Short sale constraints, Degree of mispricing, Asymmetric pricing effect, Benchmark-adjusted returns

JEL Classification: G12, G14

Suggested Citation

Kim, Dongcheol and Lee, Inro and Na, Haejung, Financial Distress, Short Sale Constraints, and Mispricing (October 27, 2018). Pacific-Basin Finance Journal, Vol. 53, No. 1, 2019. Available at SSRN:

Dongcheol Kim (Contact Author)

Korea University Business School ( email )

Anam-Dong, Seongbuk-Gu
Seoul 136-701, 136701
+82-2-3290-2606 (Phone)

Inro Lee

The Bank of Korea ( email )

39, Namdaemun-ro, Jung-gu
Seoul, 04531
Korea, Republic of (South Korea)

Haejung Na

California State University, Los Angeles ( email )

5151 State University Dr.
Simpson Tower F316
Los Angeles, CA CA 90032
United States
323-343-2871 (Phone)

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