In Search of Distress Risk





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    • John Y. Campbell is with the Department of Economics, Harvard University and NBER. Jens Hilscher is with the International Business School, Brandeis University. Jan Szilagyi is with Duquesne Capital Management LLC. The views expressed in this paper are those of the authors and do not necessarily represent the views of the authors' employers. This material is based upon work supported by the National Science Foundation under Grant No. 0214061 to Campbell. We would like to thank Robert Jarrow and Don van Deventer of Kamakura Risk Information Services (KRIS) for providing us with data on corporate bankruptcies and failures; Boris Kovtunenko and Nathan Sosner for their assistance with the Spectrum data set; Laura Serban and Adi Sunderam for research assistance, and an anonymous referee, Kent Daniel, Stuart Gilson, John Griffin, Kose John, Scott Richardson, Myron Scholes, Tyler Shumway, Bruno Solnik, Jeremy Stein, Ulf von Kalckreuth, Lu Zhang; and seminar participants at Humboldt Universität zu Berlin, HEC Paris, the University of Texas, the Wharton School, the Deutsche Bundesbank 2005 Spring Conference, the 2006 Credit Risk Conference at NYU, the 2006 NBER Behavioral Finance meeting, the Conference on Credit Risk and Credit Derivatives at the Federal Reserve Board, and the Seventh Maryland Finance Symposium for helpful comments.


This paper explores the determinants of corporate failure and the pricing of financially distressed stocks whose failure probability, estimated from a dynamic logit model using accounting and market variables, is high. Since 1981, financially distressed stocks have delivered anomalously low returns. They have lower returns but much higher standard deviations, market betas, and loadings on value and small-cap risk factors than stocks with low failure risk. These patterns are more pronounced for stocks with possible informational or arbitrage-related frictions. They are inconsistent with the conjecture that the value and size effects are compensation for the risk of financial distress.