Feedback and Contagion through Distressed Competition

The Rodney L. White Center Working Papers Series at the Wharton School

Jacobs Levy Equity Management Center for Quantitative Financial Research Paper

61 Pages Posted: 5 Feb 2020 Last revised: 10 Sep 2020

See all articles by Hui Chen

Hui Chen

Massachusetts Institute of Technology; National Bureau of Economic Research (NBER)

Winston Dou

The Wharton School, University of Pennsylvania

Hongye Guo

University of Pennsylvania

Yan Ji

Hong Kong University of Science & Technology (HKUST)

Date Written: September 8, 2020

Abstract

Firms tend to compete more aggressively in financial distress; the intensified competition in turn reduces profit margins for everyone, pushing some further into distress. To study such feedback and contagion effects, we incorporate dynamic strategic competition into an industry equilibrium with long-term defaultable debt, which generates various peer interactions: predation, self-defense, and collaboration. Such interactions make cash flows, stock returns, and credit spreads interdependent across firms. Moreover, industries with higher idiosyncratic-jump risks are more distressed, yet also endogenously less exposed to aggregate shocks. Finally, we exploit exogenous variations in market structure -- large tariff cuts -- to test the core competition mechanism.

Keywords: Stock and Bond Returns, Supergames, Predatory Price Wars, Collective Entry Prevention, Tacit Collusion, Financial Distress Anomaly

JEL Classification: G12, L13, O33, C73

Suggested Citation

Chen, Hui and Dou, Winston and Guo, Hongye and Ji, Yan, Feedback and Contagion through Distressed Competition (September 8, 2020). The Rodney L. White Center Working Papers Series at the Wharton School, Jacobs Levy Equity Management Center for Quantitative Financial Research Paper, Available at SSRN: https://ssrn.com/abstract=3513296 or http://dx.doi.org/10.2139/ssrn.3513296

Hui Chen

Massachusetts Institute of Technology ( email )

50 Memorial Drive
Cambridge, MA 02142
United States
617-324-3896 (Phone)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Winston Dou (Contact Author)

The Wharton School, University of Pennsylvania ( email )

2318 Steinberg Hall - Dietrich Hall
3620 Locust Walk
Philadelphia, PA 19104
United States

Hongye Guo

University of Pennsylvania ( email )

Yan Ji

Hong Kong University of Science & Technology (HKUST) ( email )

Clearwater Bay
Kowloon, 999999
Hong Kong

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