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Distressed Stocks in Distressed Times

Author

Listed:
  • Assaf Eisdorfer

    (School of Business, University of Connecticut, Storrs, Connecticut 06269)

  • Efdal Ulas Misirli

    (Quantitative Supervision and Research Department, Federal Reserve Bank of Richmond, Baltimore, Maryland 21201)

Abstract

We partially explain the well-documented distress anomaly by studying the risk/return relation of distressed stocks across market states. We show that the anomaly does not hold in market downturns. The asset beta and financial leverage of distressed stocks rise significantly during bear markets, resulting in a dramatic increase in their equity beta. Hence, a long/short healthy-minus-distressed trading strategy leads to significant losses when the market rebounds. Managing this risk mitigates the severe losses of financial distress strategies and significantly improves their Sharpe ratios. Our results remain strongly significant controlling for the momentum effect and are robust to various estimation procedures.

Suggested Citation

  • Assaf Eisdorfer & Efdal Ulas Misirli, 2020. "Distressed Stocks in Distressed Times," Management Science, INFORMS, vol. 66(6), pages 2452-2473, June.
    • Handle: RePEc:inm:ormnsc:v:66:y:2020:i:6:p:2452-2473
    DOI: 10.1287/mnsc.2019.3314
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    Cited by:

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    4. Lykourgos Alexiou & Leonidas S. Rompolis, 2022. "Option‐implied moments and the cross‐section of stock returns," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 42(4), pages 668-691, April.

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