45 Pages Posted: 7 Feb 2005
Date Written: August 3, 2005
Past accruals anomaly studies have documented results that suggest that distress risk increases systematically across decreasing accruals portfolios. I investigate and find a negative relation between accruals and distress risk, evidence that suggests that the accruals trading strategy of buying firms with low accruals and selling firms with high accruals results in exposure to higher distress risk. I show that distress risk is compensated by higher future returns. I then show that the future abnormal returns from the accruals trading strategy decline after controlling for distress risk. This evidence suggests that that at least part of the high abnormal returns to the accruals trading strategy should be reclassified as normal returns for engaging in a trading strategy that involves higher distress risk. In addition, I find that the abnormal returns to the accruals trading strategy are largely driven by trading in firms within high distress risk portfolios.
Keywords: Accruals, asset pricing, distress risk, market efficiency, mispricing
JEL Classification: G12, G14, G33, M41, M43
Suggested Citation: Suggested Citation