Book‐to‐Market Equity, Distress Risk, and Stock Returns

Abstract

This paper examines the relationship between book-to-market equity, distress risk, and stock returns. Among firms with the highest distress risk as proxied by Ohlson's~1980! O-score, the difference in returns between high and low book-tomarket securities is more than twice as large as that in other firms. This large return differential cannot be explained by the three-factor model or by differences in economic fundamentals. Consistent with mispricing arguments, firms with high distress risk exhibit the largest return reversals around earnings announcements, and the book-to-market effect is largest in small firms with low analyst coverage.

Rationalizing the value premium in emerging markets

“…Alternatively, a positive relationship implies the two variables contain different information that is potentially related to differences in relative risk across firms (see Dichev, 1998;Griffin and Lemmon, 2002). In the context of this paper, we argue that the relative risk results from the idiosyncratic characteristics of each firm.…”

“…10 Fama and French (1993) and Chen and Zhang (1998) offer empirical evidence to suggest high value firms are assigned a higher risk premium because they have a higher probability of distress, implying that bankruptcy risk is a systemic factor. Dichev (1998) and Griffin and Lemmon (2002) offer empirical evidence to reject the conjecture that bankruptcy risk is systematic and rewarded by higher returns. In 8 This criterion is required to address the issue of survival bias (see Banz and Breen, 1986;Kothari, et al, 1995).…”

“…Fama and French (1995) develop a three-factor model, in which the factor that captures distress risk, known as HML, is lower for growth (glamour) firms than for value firms. The debate centers on whether lower distress risk accounts for the discrepancy in average returns between value firms and growth firms (Fama and French, 1995) against claims that distress risk does not contribute to the value premium (Dichev, 1998;Griffin and Lemmon, 2002). We contend that both the cash-drag factors and firm characteristics, as highlighted by Daniel and Titman (1997), are of relevance.…”

Does a lot help a lot? Forecasting stock returns with pooling strategies in a data‐rich environment

“…Following this argument, Lakonishok et al (1994) and Griffin and Lemmon (2002) find no evidence that the return differential between value and growth stocks can be explained by economic fundamentals. There is even a controversial debate for the size premium, whether systematic risk factors might explain this return differential, especially after the 1980s when the small-firm anomaly seems to disappear, as has been mentioned by Horowitz, Loughran, and Savin (2000), among others.…”

“…Although stock return predictability was accepted for a long time, Goyal and Welch (2008), Timmermann (2008), Griffin, Ji, and Martin (2003), and Griffin and Lemmon (2002), among others, show that commonly used predictors perform poorly in an out-of-sample (OOS) setting, especially during more recent decades, which cast doubt on the empirical linkage between macroeconomic fundamentals and stock returns. More recently, Rapach and Zhou (2013) provide a survey of further approaches attempting to improve the forecast performance.…”