TY - JOUR AU - Campbell,John Y. AU - Hilscher,Jens AU - Szilagyi,Jan TI - In Search of Distress Risk JF - National Bureau of Economic Research Working Paper Series VL - No. 12362 PY - 2006 Y2 - July 2006 DO - 10.3386/w12362 UR - http://www.nber.org/papers/w12362 L1 - http://www.nber.org/papers/w12362.pdf N1 - Author contact info: John Y. Campbell Morton L. and Carole S. Olshan Professor of Economics Department of Economics Harvard University Littauer Center 213 Cambridge, MA 02138 Tel: 617/496-6448 Fax: 617/495-7730 E-Mail: john_campbell@harvard.edu Jens Hilscher Brandeis University International Business School Lemberg Academic Center 252 415 South Street Waltham, MA 02454-9110 Tel: (617) 945 8828 E-Mail: hilscher@brandeis.edu Jan Szilagyi 330 West 85th Street Apt 4H New York NY, 10024 E-Mail: jan@duquesne.com AB - This paper explores the determinants of corporate failure and the pricing of financially distressed stocks using US data over the period 1963 to 2003. Firms with higher leverage, lower profitability, lower market capitalization, lower past stock returns, more volatile past stock returns, lower cash holdings, higher market-book ratios, and lower prices per share are more likely to file for bankruptcy, be delisted, or receive a D rating. When predicting failure at longer horizons, the most persistent firm characteristics, market capitalization, the market-book ratio, and equity volatility become relatively more significant. Our model captures much of the time variation in the aggregate failure rate. Since 1981, financially distressed stocks have delivered anomalously low returns. They have lower returns but much higher standard deviations, market betas, and loadings on value and small-cap risk factors than stocks with a low risk of failure. These patterns hold in all size quintiles but are particularly strong in smaller stocks. They are inconsistent with the conjecture that the value and size effects are compensation for the risk of financial distress. ER -