A unified model of distress risk puzzles

Zhiyao Chen, Dirk Hackbarth and Ilya A. Strebulaev

Journal of Financial Economics, 2022, vol. 146, issue 2, 357-384

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.

Keywords: Distress risk premium; Failure probability; Endogenous debt financing; Endogenous distress; Financial leverage (search for similar items in EconPapers)
JEL-codes: G13 G31 G32 G33 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S0304405X21004402
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:146:y:2022:i:2:p:357-384

DOI: 10.1016/j.jfineco.2021.10.001

Access Statistics for this article

Journal of Financial Economics is currently edited by G. William Schwert

More articles in Journal of Financial Economics from Elsevier
Bibliographic data for series maintained by Catherine Liu ().