Does the Bond Market Predict Bankruptcy Settlements?




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    • School of Business Administration, Georgetown University. This is a substantially revised version of our earlier paper, “Bond Prices as Unbiased Forecasts of Bankruptcy Settlements.” We would like to thank Reena Aggarwal, Ed Altaian, Bill Baber, Brian Betker, Lisa Fairchild, Jerome Fons, Stuart Gilson, Michael Jensen, Dana Johnson, Imre Karafiath, Alan Roshwalb, Lemma Senbet, Arthur Warga, Jerry Warner, and seminar participants at the 1992 meetings of the American Finance Association, American University, Georgetown University Workshop on Financial Distress and Bankruptcy, Lund University, University of Maryland, New York University Conference on Corporate Bankruptcy and Distressed Restructurings and the Stockholm School of Economics for many insightful comments. We would also like to thank Kenji Berliner, Peter Eldredge and, especially, Mario Mansilla for their excellent research assistance. We received funding from Georgetown University summer research grants. The Center for Business-Government Relations at Georgetown (directed by David Walker) also provided support.


This study shows the extent to which deviations from the absolute priority rule increase or decrease the bankruptcy emergence payoff to traded (i.e., usually junior claimants) bondholders. The data indicate that, on average, bondholders benefit, albeit slightly, from absolute priority rule (APR) violations. This paper also examines the degree to which the bond market, in the bankruptcy filing month, anticipates departures from the APR and other influences on the payoff to bondholders. In other words, we investigate the informational efficiency of the market for bankrupt bonds. Overall, despite the complex and lengthy nature of bankruptcy proceedings, the results support efficiency.