Is the Risk of Bankruptcy a Systematic Risk?

  • Author(s): Ilia D. Dichev
  • Published: Dec 17, 2002
  • Pages: 1131-1147
  • DOI: 10.1111/0022-1082.00046

Several studies suggest that a firm distress risk factor could be behind the size and the book‐to‐market effects. A natural proxy for firm distress is bankruptcy risk. If bankruptcy risk is systematic, one would expect a positive association between bankruptcy risk and subsequent realized returns. However, results demonstrate that bankruptcy risk is not rewarded by higher returns. Thus, a distress factor is unlikely to account for the size and book‐to‐market effects. Surprisingly, firms with high bankruptcy risk earn lower than average returns since 1980. A risk‐based explanation cannot fully explain the anomalous evidence.

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