A unified model of distress risk puzzles

Zhiyao Chen; Dirk Hackbarth; Ilya A. Strebulaev

doi:10.1016/j.jfineco.2021.10.001

A unified model of distress risk puzzles

Zhiyao Chen^*, Dirk Hackbarth, Ilya A. Strebulaev

^*Corresponding author for this work

Research output: Journal Publications and Reviews › RGC 21 - Publication in refereed journal › peer-review

8 Citations (Scopus)

Abstract

We document that (i) debt-to-equity ratios and levered equity betas negatively covary with the market risk premium in distressed firms; (ii) the negative covariance generates negative alphas among those firms. We build a dynamic credit risk model to understand the negative covariance between equity betas and the market risk premium, via endogenous and dynamic debt financing over the business cycles. Because of endogenous debt financing and distress, our model naturally connects the negative failure probability-return relation to the positive distress risk premium-return relation. © 2022 Elsevier B.V.

Original language	English
Pages (from-to)	357-384
Journal	Journal of Financial Economics
Volume	146
Issue number	2
Online published	4 Aug 2021
DOIs	https://doi.org/10.1016/j.jfineco.2021.10.001
Publication status	Published - Nov 2022
Externally published	Yes

Funding

Zhiyao Chen acknowledges financial support from the General Research Fund by the Hong Kong Research Grants Council [grant number 14519816].

Research Keywords

Distress risk premium
Endogenous debt financing
Endogenous distress
Failure probability
Financial leverage

Access Output

10.1016/j.jfineco.2021.10.001

Other Access Options

Check CityUHK Library

Permanent Link

Right click to copy link

Cite this

@article{b99593066fb746e5a20ddee11dd9d40f,

title = "A unified model of distress risk puzzles",

abstract = "We document that (i) debt-to-equity ratios and levered equity betas negatively covary with the market risk premium in distressed firms; (ii) the negative covariance generates negative alphas among those firms. We build a dynamic credit risk model to understand the negative covariance between equity betas and the market risk premium, via endogenous and dynamic debt financing over the business cycles. Because of endogenous debt financing and distress, our model naturally connects the negative failure probability-return relation to the positive distress risk premium-return relation. {\textcopyright} 2022 Elsevier B.V.",

keywords = "Distress risk premium, Endogenous debt financing, Endogenous distress, Failure probability, Financial leverage",

author = "Zhiyao Chen and Dirk Hackbarth and Strebulaev, {Ilya A.}",

year = "2022",

month = nov,

doi = "10.1016/j.jfineco.2021.10.001",

language = "English",

volume = "146",

pages = "357--384",

journal = "Journal of Financial Economics",

issn = "0304-405X",

publisher = "Elsevier B.V.",

number = "2",

}

TY - JOUR

T1 - A unified model of distress risk puzzles

AU - Chen, Zhiyao

AU - Hackbarth, Dirk

AU - Strebulaev, Ilya A.

PY - 2022/11

Y1 - 2022/11

N2 - We document that (i) debt-to-equity ratios and levered equity betas negatively covary with the market risk premium in distressed firms; (ii) the negative covariance generates negative alphas among those firms. We build a dynamic credit risk model to understand the negative covariance between equity betas and the market risk premium, via endogenous and dynamic debt financing over the business cycles. Because of endogenous debt financing and distress, our model naturally connects the negative failure probability-return relation to the positive distress risk premium-return relation. © 2022 Elsevier B.V.

AB - We document that (i) debt-to-equity ratios and levered equity betas negatively covary with the market risk premium in distressed firms; (ii) the negative covariance generates negative alphas among those firms. We build a dynamic credit risk model to understand the negative covariance between equity betas and the market risk premium, via endogenous and dynamic debt financing over the business cycles. Because of endogenous debt financing and distress, our model naturally connects the negative failure probability-return relation to the positive distress risk premium-return relation. © 2022 Elsevier B.V.

KW - Distress risk premium

KW - Endogenous debt financing

KW - Endogenous distress

KW - Failure probability

KW - Financial leverage

UR - http://www.scopus.com/inward/record.url?scp=85131854909&partnerID=8YFLogxK

UR - https://www.scopus.com/record/pubmetrics.uri?eid=2-s2.0-85131854909&origin=recordpage

U2 - 10.1016/j.jfineco.2021.10.001

DO - 10.1016/j.jfineco.2021.10.001

M3 - RGC 21 - Publication in refereed journal

SN - 0304-405X

VL - 146

SP - 357

EP - 384

JO - Journal of Financial Economics

JF - Journal of Financial Economics

IS - 2

ER -

A unified model of distress risk puzzles

Abstract

Funding

Research Keywords

Access Output

Other Access Options

Permanent Link

Other Files and Links

Fingerprint

Cite this