Is the Risk of Bankruptcy a Systematic Risk?


  • Ilia D. Dichev

    1. University of Michigan Business School
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    • University of Michigan Business School. I am grateful to my dissertation committee, Dave Burgstahler (chair), Terry Shevlin, Thomas Hemmer, and Ed Rice for their guidance and help. I appreciate the helpful comments of Jeff Abarbanell, Mark Bradshaw, Dave Ikenberry, Russ Lundholm, Jim Ohlson, Tyler Shumway, René Stulz, an anonymous referee, and research seminar participants at Michigan, M.I.T. Penn State, Rice, Rutgers, UCLA, Washington, and the Societies of Financial Analysts in Houston and Seattle. The Deloitte and Touche Foundation provided financial support.


Several studies suggest that a firm distress risk factor could be behind the size and the book-to-market effects. A natural proxy for firm distress is bankruptcy risk. If bankruptcy risk is systematic, one would expect a positive association between bankruptcy risk and subsequent realized returns. However, results demonstrate that bankruptcy risk is not rewarded by higher returns. Thus, a distress factor is unlikely to account for the size and book-to-market effects. Surprisingly, firms with high bankruptcy risk earn lower than average returns since 1980. A risk-based explanation cannot fully explain the anomalous evidence.