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Market-Based Solutions to Vital Economic Issues
Research
Dec 22, 2017

Understanding the Behavior of Distressed Stocks

Abstract

This paper argues that the seemingly lower returns on distressed stocks are partly the result of estimation bias and proposes an exact theoretical correction that can be applied in practice. The bias emerges because financial distress induces sharply countercyclical nonlinear movements in betas that are not well captured by standard linear factor pricing models. We show that this can lead to sizably negative abnormal excess returns. After implementing our proposed correction we see much less evidence of underperformance for portfolios of distressed stocks in the data.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.

Citation

Boualam, Y., Gomes, J., Ward, C. Understanding the Behavior of Distressed Stocks

 


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