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Are the Fama-French factors really compensation for distress risk?

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Listed:
  • de Groot, Wilma
  • Huij, Joop

Abstract

In this paper, we revisit the question whether the Fama-French factors are manifestation of distress risk premiums. To this end, we develop new tests specifically aimed at dissecting the Fama-French factor returns from a distress risk premium. While we find that value and small-cap exposures are typically associated with distress risk, our results also indicate that distress risk is not priced and that the small-cap and value premiums are priced beyond distress risk. Moreover, the distress risk exposures of common small-cap and value factors do not have explanatory power in asset pricing tests. Our results are robust to international out-of-sample analyses and have important implications for investors engaging in small-cap and value strategies.

Suggested Citation

  • de Groot, Wilma & Huij, Joop, 2018. "Are the Fama-French factors really compensation for distress risk?," Journal of International Money and Finance, Elsevier, vol. 86(C), pages 50-69.
  • Handle: RePEc:eee:jimfin:v:86:y:2018:i:c:p:50-69
    DOI: 10.1016/j.jimonfin.2018.03.002
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    References listed on IDEAS

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    More about this item

    Keywords

    Book-to-market effect; Value anomaly; Small-cap effect; Market efficiency; Default risk; Bankruptcy; Credit spread; Bond spread; Distress risk; Credit rating;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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