Affiliation:
1. Department of Finance and Real Estate, College of Business, University of Texas at Arlington, 701 S W St, Arlington, TX 76010, USA
Abstract
This study investigates the contradiction in the finding of a positive distress risk premium in Vassalou and Xing’s study and the finding of a negative distress risk premium, i.e., a distress risk discount, in several other studies. Using the default likelihood measure calculated following Vassalou and Xing’s procedure for 1965–2023, we show that excluding outliers and including the time period beyond the end of Vassalou and Xing’s sample period in 1999 makes a difference in the results. Overall, using portfolio sorting and Fama-MacBeth regressions, this study supports the existence of a distress risk discount. This study also documents that the financial distress risk is negatively reflected in security prices even after accounting for size and book-to-market risk factors. Furthermore, it demonstrates that the negative distress risk premium is strong and persistent across economic expansions, recessions, and the COVID-19 pandemic.
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