The Global Relation between Financial Distress and Equity Returns

The Review of Financial Studies, Forthcoming

86 Pages Posted: 19 Jun 2012 Last revised: 3 Jun 2017

See all articles by Pengjie Gao

Pengjie Gao

University of Notre Dame - Mendoza College of Business

Christopher A. Parsons

Marshall School of Business, University of Southern California

Jianfeng Shen

UNSW Business School, University of New South Wales

Date Written: October 24, 2016

Abstract

This study explores the distress risk anomaly — the tendency for stocks with high credit risk to perform poorly — among 38 countries over two decades. We find a strong, negative link between default probabilities and equity returns, concentrated among low-capitalization stocks in developed countries in North America and Europe. Although risk-based explanations provide a poor account of these patterns, several pieces of evidence point to a behavioral interpretation, suggesting that stocks of firms in financial distress are temporarily overpriced.

Keywords: financial distress, equity return, individualism, overconfidence

JEL Classification: G12, G14

Suggested Citation

Gao, Pengjie and Parsons, Christopher A. and Shen, Jianfeng, The Global Relation between Financial Distress and Equity Returns (October 24, 2016). The Review of Financial Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2086475 or http://dx.doi.org/10.2139/ssrn.2086475

Pengjie Gao (Contact Author)

University of Notre Dame - Mendoza College of Business ( email )

246 Mendoza College of Business
Notre Dame, IN 46556-5646
United States
(574) 631-8048 (Phone)

HOME PAGE: http://​sites.google.com/site/gpengjie/

Christopher A. Parsons

Marshall School of Business, University of Southern California ( email )

3670 Trousdale Pkwy
Los Angeles, CA 90089
United States

Jianfeng Shen

UNSW Business School, University of New South Wales ( email )

School of Banking and Finance
UNSW Sydney, NSW 2052
Australia

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