Financial Distress and the Cross Section of Equity Returns
In this paper, we provide a new perspective for understanding cross-sectional properties of equity returns. We explicitly introduce fiancial leverage in a simple equity valuation model and consider the likelihood of a firm defaulting on its debt obligations as well as potential deviations from the absolute priority rule (APR) upon the resolution of fiancial distress. We show that fiancial leverage amplifies the magnitude of the book-to-market effect and hence provide an explanation for the empirical evidence that value premia are larger among firms with a higher likelihood of fiancial distress. By further allowing for APR violations, our model generates two novel predictions about the cross section of equity returns: (i) the value premium (computed as the difference between expected returns on mature and growth firms), is hump- shaped with respect to default probability, and (ii) firms with a higher likelihood of deviation from the APR upon fiancial distress generate stronger momentum profits. Both predictions are confirmed in our empirical tests. These results emphasize the unique role of fiancial distress- and the nonlinear relationship between equity risk and firm characteristics-in understanding cross-sectional properties of equity returns.
Financial distress value premium momentum growth options
Lorenzo Garlappi Hong Yan
Department of Finance,McCombs School of Business,University of Texas at Austin,Austin,TX 78712 Department of Finance,Moore School of Business,University of South Carolina,Columbia,SC 29208
国际会议
大连
英文
1-55
2008-07-02（万方平台首次上网日期，不代表论文的发表时间）