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Financial Distress and Idiosyncratic Volatility: An Empirical Investigation

Author

Listed:
  • Chen, Jing

    () (Columbia University, Graduate School of Business)

  • Chollete, Lorán

    () (Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration)

Abstract

We address the twin puzzles of anomalously low returns for high idiosyncratic volatility and high distress risk stocks, documented by Ang, Hodrick, Xing and Zhang (2006) and Campbell, Hilscher and Szilagyi (2005), respectively. We accomplish two objectives in this study. First, we investigate the link between idiosyncratic volatility and distress risk and find that the idiosyncratic volatility effect exists only conditionally on high distress risk. Second, using a corrected single-beta CAPM model, we provide a rational explanation for the twin puzzles. Joint statistical tests cannot reject the null hypothesis of zero abnormal returns across the idiosyncratic volatility and distress risk portfolios, for the corrected model.

Suggested Citation

  • Chen, Jing & Chollete, Lorán, 2006. "Financial Distress and Idiosyncratic Volatility: An Empirical Investigation," Discussion Papers 2006/8, Norwegian School of Economics, Department of Business and Management Science.
  • Handle: RePEc:hhs:nhhfms:2006_008
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    File URL: http://hdl.handle.net/11250/164104
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    References listed on IDEAS

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    1. Newey, Whitney K & West, Kenneth D, 1987. "Hypothesis Testing with Efficient Method of Moments Estimation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 777-787, October.
    2. Roll, Richard, 1977. "A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory," Journal of Financial Economics, Elsevier, vol. 4(2), pages 129-176, March.
    3. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    4. John Y. Campbell & Glen B. Taksler, 2003. "Equity Volatility and Corporate Bond Yields," Journal of Finance, American Finance Association, vol. 58(6), pages 2321-2350, December.
    5. repec:bla:joares:v:18:y:1980:i:1:p:109-131 is not listed on IDEAS
    6. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross-Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    7. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    8. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-1152, September.
    9. Ilia D. Dichev, 1998. "Is the Risk of Bankruptcy a Systematic Risk?," Journal of Finance, American Finance Association, vol. 53(3), pages 1131-1147, June.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    Distress risk; idiosyncratic volatility; single-beta CAPM;

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General

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