Clientele Change, Liquidity Shock, and the Return on Financially Distressed Stocks
58 Pages Posted: 17 Mar 2006
Date Written: November 29, 2005
We provide empirical evidence supporting the view that a sharp rise in a firm's default likelihood causes a change in its shareholder clientele: mutual funds decrease their holdings of the firm's share, trading volume and cost increase, and the order imbalance measure indicates large selling pressure. The liquidity risk of the stock as measured by its exposure to the Pástor and Stambaugh (2003) liquidity factor rises. Liquidity risk of the stock returns to normal in the subsequent month and the stock price recovers. Such price recovery explains the first-month abnormal high return earned by stocks with high default likelihood documented in Vassalou and Xing (2004). The abnormal high return is mostly reward for providing liquidity when it is most needed.
Keywords: Clientele, Liquidity, Default Risk, Stock Return
JEL Classification: G12, G14
Suggested Citation: Suggested Citation