Limit to Arbitrage and Distress Risk Puzzle in Vietnam: Does Corporate Bankruptcy Regulation Matter?

Abstract

This study is the first to examine how limit-to-arbitrage factors impact the distress risk puzzle in Vietnam before and after implementing bankruptcy regulations. Our research utilizes asset pricing models, portfolio sorting methodologies, and the Fama and French four-factor model to analyze an unbalanced panel with 35,255 firm-month observations from non-financial firms in the Vietnam stock market from 2008 to 2021. We find a persistent negative correlation between distress risk and corporate profitability, even after accounting for limit-to-arbitrage factors. Notably, this trend is more pronounced among larger firms. Intriguingly, the distress risk puzzle disappears after the introduction of bankruptcy regulations. Additionally, we observe that limit-to-arbitrage factors suppress stock returns due to mispricing issues, supporting liquidity risk theory. Our study provides valuable insights into the distress risk puzzle, especially in emerging markets. JEL Classification: G11, G12, G14.