Financial distress and equity returns: A leverage-augmented three-factor model

Sabri Boubaker, Taher Hamza and Javier Vidal-García

Research in International Business and Finance, 2018, vol. 46, issue C, 1-15

Abstract: Our study examines whether financial distress risk is systematic risk using twelve portfolios sorted by size, book-to-market, and leverage and a portfolio of distressed firms covering an 18-year period. It also tests the explanatory power of the risk factors that best capture default risk. The empirical findings show that: (i) equity portfolio investment requires systematically both size and value premiums and that SMB and HML capture additional risk missed by the market portfolio; (ii) the leverage risk premium is positive for highly leveraged firms; and (iii) the risk premium for the relative distress factor is significant only for the distressed firm portfolio. Overall, our results have practical implications for portfolio managers since they advocate a leverage-augmented three-factor model to accurately price assets and to implement efficient portfolio strategies.

Keywords: Financial distress; Equity returns; Fama-French three-factor model (search for similar items in EconPapers)
JEL-codes: G12 G33 (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:riibaf:v:46:y:2018:i:c:p:1-15

DOI: 10.1016/j.ribaf.2016.09.003

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