Fire Sale Risk and Expected Stock Returns

Abstract

We measure a stock's exposure to fire sale risk through its ownership links to mutual funds that anticipate significant outflows during periods of systematic outflows from the fund industry. We find that stocks with higher exposure to this risk earn higher average returns: a portfolio that buys (shorts) stocks with the highest (lowest) exposure outperforms by 3-7% annually. Our findings cannot be explained by several known determinants of average returns and support the ex-ante pricing of the risk of fire sales. We conclude that stocks' exposures to risks inherited from the constraints of shareholders have important implications for stock prices.

Keywords: fire sales, stock returns, ownership, mutual fund, fund flows

JEL Classification: G11, G12, G23