The Global Relation between Financial Distress and Equity Returns
This study explores the distress risk anomaly the tendency for stocks with high credit risk to perform poorly among 38 countries over two decades. We find a strongly negative relationship between default probabilities and equity returns concentrated among low capitalization stocks in developed countries in North America and Europe. Although risk based explanations provide a poor account of these patterns, several pieces of evidence point to a behavioral interpretation, suggesting that stocks of firms in financial distress are temporarily overpriced. Received March 5, 2013; editorial decision December 4, 2016 by Editor Andrew Karolyi.