Revisiting the Relation between Distress Risk and Stock Returns

35 Pages Posted: 31 Jul 2008 Last revised: 1 Feb 2010

See all articles by Michael S. O'Doherty

Michael S. O'Doherty

University of Missouri at Columbia - Department of Finance

Date Written: January 19, 2010

Abstract

Several prior studies use reduced-form models of bankruptcy or default risk to proxy for corporate distress and find evidence of a significant negative relation between distress risk and average returns. This paper introduces a substantially broader measure of firm failure risk, the probability a firm is delisted from a major U.S. stock exchange for performance reasons, and revisits the pricing of distressed stocks. In contrast to the prior literature, I find distressed stocks earn higher average returns than those with a low probability of failure. Moreover, distress risk is significantly priced in the cross section. While the size and value effects remain robust to controlling for failure risk, I find evidence that SMB and HML contain some distress-related information.

Keywords: Distress risk, performance delisting, hazard model, value effect, size effect, financial distress

JEL Classification: G11, G12, G33

Suggested Citation

O'Doherty, Michael S., Revisiting the Relation between Distress Risk and Stock Returns (January 19, 2010). Available at SSRN: https://ssrn.com/abstract=1189805 or http://dx.doi.org/10.2139/ssrn.1189805

Michael S. O'Doherty (Contact Author)

University of Missouri at Columbia - Department of Finance ( email )

Robert J. Trulaske, Sr. College of Business
401 Cornell Hall
Columbia, MO 65211
United States

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