On the Conditional Risk and Performance of Financially Distressed Stocks
Management Science · 2012 · Volume 58 · Issue 8
Abstract
Several recent articles find that stocks with high probabilities of bankruptcy or default earn anomalously low returns and negative unconditional capital asset pricing model (CAPM) alphas in the post-1980 period. I show that the conditional CAPM resolves the performance difference between high- and low-distress stocks. In particular, financially distressed stocks have relatively low exposure to market risk during bad economic times. I help to explain these findings through a theoretical model in which a levered firm's equity beta is negatively related to uncertainty about the unobserved value of its underlying assets. This paper was accepted by Wei Xiong, finance.
Keywords
conditional CAPM, asset-pricing anomalies, distress risk, default risk, information risk
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