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Financial Distress and Idiosyncratic Volatility: An Empirical Investigation

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  • 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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    JEL classification:

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

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