IDEAS home Printed from https://ideas.repec.org/a/bla/finmgt/v37y2008i3p461-484.html
   My bibliography  Save this article

Does Financial Distress Risk Drive the Momentum Anomaly?

Author

Listed:
  • Vineet Agarwal
  • Richard Taffler

Abstract

This paper brings together the evidence on two asset pricing anomalies—continuation of prior returns (momentum) and the market mispricing of distressed firms—using UK data. Our analysis demonstrates both these effects are driven by market underreaction to financial distress risk. In particular, we find momentum is proxying for distress risk, and is largely subsumed by our distress risk factor. We also find, as with US studies, no evidence that size and book‐to‐market (B/M) effects in stock returns are linked to financial distress.

Suggested Citation

  • Vineet Agarwal & Richard Taffler, 2008. "Does Financial Distress Risk Drive the Momentum Anomaly?," Financial Management, Financial Management Association International, vol. 37(3), pages 461-484, September.
    • Handle: RePEc:bla:finmgt:v:37:y:2008:i:3:p:461-484
    DOI: 10.1111/j.1755-053X.2008.00021.x
    as

    Download full text from publisher

    File URL: https://doi.org/10.1111/j.1755-053X.2008.00021.x
    Download Restriction: no
    File URL: https://libkey.io/10.1111/j.1755-053X.2008.00021.x?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    References listed on IDEAS

    as
    1. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    2. Harrison Hong & Terence Lim & Jeremy C. Stein, 2000. "Bad News Travels Slowly: Size, Analyst Coverage, and the Profitability of Momentum Strategies," Journal of Finance, American Finance Association, vol. 55(1), pages 265-295, February.
    3. Lamont, Owen & Polk, Christopher & Saa-Requejo, Jesus, 2001. "Financial Constraints and Stock Returns," The Review of Financial Studies, Society for Financial Studies, vol. 14(2), pages 529-554.
    4. Fama, Eugene F., 1998. "Market efficiency, long-term returns, and behavioral finance," Journal of Financial Economics, Elsevier, vol. 49(3), pages 283-306, September.
    5. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, September.
    6. John M. Griffin & Michael L. Lemmon, 2002. "Book‐to‐Market Equity, Distress Risk, and Stock Returns," Journal of Finance, American Finance Association, vol. 57(5), pages 2317-2336, October.
    7. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    8. John Y. Campbell & Jens Hilscher & Jan Szilagyi, 2008. "In Search of Distress Risk," Journal of Finance, American Finance Association, vol. 63(6), pages 2899-2939, December.
    9. Beaver, Wh, 1968. "Market Prices, Financial Ratios, And Prediction Of Failure," Journal of Accounting Research, Wiley Blackwell, vol. 6(2), pages 179-192.
    10. Chan, K C & Chen, Nai-Fu, 1991. "Structural and Return Characteristics of Small and Large Firms," Journal of Finance, American Finance Association, vol. 46(4), pages 1467-1484, September.
    11. Barberis, Nicholas & Shleifer, Andrei & Vishny, Robert, 1998. "A model of investor sentiment," Journal of Financial Economics, Elsevier, vol. 49(3), pages 307-343, September.
    12. Lo, Andrew W & MacKinlay, A Craig, 1990. "Data-Snooping Biases in Tests of Financial Asset Pricing Models," The Review of Financial Studies, Society for Financial Studies, vol. 3(3), pages 431-467.
    13. Taffler, Richard J., 1984. "Empirical models for the monitoring of UK corporations," Journal of Banking & Finance, Elsevier, vol. 8(2), pages 199-227, June.
    14. Narasimhan Jegadeesh & Sheridan Titman, 2001. "Profitability of Momentum Strategies: An Evaluation of Alternative Explanations," Journal of Finance, American Finance Association, vol. 56(2), pages 699-720, April.
    15. Edward I. Altman, 1968. "The Prediction Of Corporate Bankruptcy: A Discriminant Analysis," Journal of Finance, American Finance Association, vol. 23(1), pages 193-194, March.
    16. Lesmond, David A. & Schill, Michael J. & Zhou, Chunsheng, 2004. "The illusory nature of momentum profits," Journal of Financial Economics, Elsevier, vol. 71(2), pages 349-380, February.
    17. Todd Houge & Tim Loughran, 2006. "Do Investors Capture the Value Premium?," Financial Management, Financial Management Association, vol. 35(2), Summer.
    18. repec:bla:jfinan:v:53:y:1998:i:3:p:1131-1147 is not listed on IDEAS
    19. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    20. Grinblatt, Mark & Han, Bing, 2005. "Prospect theory, mental accounting, and momentum," Journal of Financial Economics, Elsevier, vol. 78(2), pages 311-339, November.
    21. Doron Avramov & Tarun Chordia & Gergana Jostova & Alexander Philipov, 2007. "Momentum and Credit Rating," Journal of Finance, American Finance Association, vol. 62(5), pages 2503-2520, October.
    22. Lee, Charles M. C., 2001. "Market efficiency and accounting research: a discussion of 'capital market research in accounting' by S.P. Kothari," Journal of Accounting and Economics, Elsevier, vol. 31(1-3), pages 233-253, September.
    23. Kevin M.J. Kaiser, 1996. "European Bankruptcy Laws: Implications for Corporations Facing Financial Distress," Financial Management, Financial Management Association, vol. 25(3), Fall.
    24. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. "Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
    25. Ilia D. Dichev & Joseph D. Piotroski, 2001. "The Long‐Run Stock Returns Following Bond Ratings Changes," Journal of Finance, American Finance Association, vol. 56(1), pages 173-203, February.
    26. Fama, Eugene F & French, Kenneth R, 1995. "Size and Book-to-Market Factors in Earnings and Returns," Journal of Finance, American Finance Association, vol. 50(1), pages 131-155, March.
    27. Dimson, Elroy, 1979. "Risk measurement when shares are subject to infrequent trading," Journal of Financial Economics, Elsevier, vol. 7(2), pages 197-226, June.
    28. repec:bla:jfinan:v:59:y:2004:i:2:p:831-868 is not listed on IDEAS
    29. Taffler, Richard J. & Lu, Jeffrey & Kausar, Asad, 2004. "In denial? Stock market underreaction to going-concern audit report disclosures," Journal of Accounting and Economics, Elsevier, vol. 38(1), pages 263-296, December.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Brooks, Chris & Godfrey, Chris & Hillenbrand, Carola & Money, Kevin, 2016. "Do investors care about corporate taxes?," Journal of Corporate Finance, Elsevier, vol. 38(C), pages 218-248.
    2. Ahsan Habib & Mabel D' Costa & Hedy Jiaying Huang & Md. Borhan Uddin Bhuiyan & Li Sun, 2020. "Determinants and consequences of financial distress: review of the empirical literature," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 60(S1), pages 1023-1075, April.
    3. Blitz, David & Huij, Joop & Martens, Martin, 2011. "Residual momentum," Journal of Empirical Finance, Elsevier, vol. 18(3), pages 506-521, June.
    4. Huang, Alex YiHou, 2012. "Asymmetric dynamics of stock price continuation," Journal of Banking & Finance, Elsevier, vol. 36(6), pages 1839-1855.
    5. Bauer, Julian & Agarwal, Vineet, 2014. "Are hazard models superior to traditional bankruptcy prediction approaches? A comprehensive test," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 432-442.
    6. Sumaira Ashraf & Elisabete G. S. Félix & Zélia Serrasqueiro, 2022. "Does board committee independence affect financial distress likelihood? A comparison of China with the UK," Asia Pacific Journal of Management, Springer, vol. 39(2), pages 723-761, June.
    7. Borisova, Ginka & Fotak, Veljko & Holland, Kateryna & Megginson, William L., 2015. "Government ownership and the cost of debt: Evidence from government investments in publicly traded firms," Journal of Financial Economics, Elsevier, vol. 118(1), pages 168-191.
    8. Assaf Eisdorfer & Amit Goyal & Alexei Zhdanov, 2018. "Distress Anomaly and Shareholder Risk: International Evidence," Financial Management, Financial Management Association International, vol. 47(3), pages 553-581, September.
    9. Jungshik Hur & Mahesh Pritamani & Vivek Sharma, 2010. "Momentum and the Disposition Effect: The Role of Individual Investors," Financial Management, Financial Management Association International, vol. 39(3), pages 1155-1176, September.
    10. González-Urteaga, Ana & Muga, Luis & Santamaria, Rafael, 2015. "Momentum and default risk. Some results using the jump component," International Review of Financial Analysis, Elsevier, vol. 40(C), pages 185-193.
    11. Merkle, Christoph & Sextroh, Christoph J., 2021. "Value and momentum from investors’ perspective: Evidence from professionals’ risk-ratings," Journal of Empirical Finance, Elsevier, vol. 62(C), pages 159-178.
    12. Cormac O’ Keeffe & Liam A. Gallagher, 2017. "The winner-loser anomaly: recent evidence from Greece," Applied Economics, Taylor & Francis Journals, vol. 49(47), pages 4718-4728, October.
    13. Abinzano, Isabel & Gonzalez-Urteaga, Ana & Muga, Luis & Sanchez, Santiago, 2020. "Performance of default-risk measures: the sample matters," Journal of Banking & Finance, Elsevier, vol. 120(C).
    14. Duxbury, Darren & Yao, Songyao, 2017. "Are investors consistent in their trading strategies? An examination of individual investor-level data," International Review of Financial Analysis, Elsevier, vol. 52(C), pages 77-87.
    15. Chris Godfrey & Chris Brooks, 2015. "The Negative Credit Risk Premium Puzzle: A Limits to Arbitrage Story," ICMA Centre Discussion Papers in Finance icma-dp2015-07, Henley Business School, University of Reading.
    16. Chan, Chia-Ying & Chou, De-Wai & Lin, Jane-Raung & Liu, Feng-Ying, 2016. "The role of corporate governance in forecasting bankruptcy: Pre- and post-SOX enactment," The North American Journal of Economics and Finance, Elsevier, vol. 35(C), pages 166-188.
    17. Alan Gregory & Rajesh Tharyan & Ian Tonks, 2013. "More than Just Contrarians: Insider Trading in Glamour and Value Firms," European Financial Management, European Financial Management Association, vol. 19(4), pages 747-774, September.
    18. Nguyet T. M. Nguyen & Abdullah Iqbal & Radha K. Shiwakoti, 2022. "The context of earnings management and its ability to predict future stock returns," Review of Quantitative Finance and Accounting, Springer, vol. 59(1), pages 123-169, July.
    19. Boubaker, Sabri & Hamza, Taher & Vidal-García, Javier, 2018. "Financial distress and equity returns: A leverage-augmented three-factor model," Research in International Business and Finance, Elsevier, vol. 46(C), pages 1-15.
    20. Chau Duong & Gioia Pescetto & Daniel Santamaria, 2014. "How value-glamour investors use financial information: UK evidence of investors' confirmation bias," The European Journal of Finance, Taylor & Francis Journals, vol. 20(6), pages 524-549, June.
    21. Gao, Li & He, Wei & Wang, Qian, 2019. "In search of distress risk in China's stock market," Global Finance Journal, Elsevier, vol. 42(C).
    22. Söhnke M. Bartram & Harald Lohre & Peter F. Pope & Ananthalakshmi Ranganathan, 2021. "Navigating the factor zoo around the world: an institutional investor perspective," Journal of Business Economics, Springer, vol. 91(5), pages 655-703, July.
    23. Ashraf, Sumaira & Félix, Elisabete G.S. & Serrasqueiro, Zélia, 2020. "Development and testing of an augmented distress prediction model: A comparative study on a developed and an emerging market," Journal of Multinational Financial Management, Elsevier, vol. 57.
    24. Chris Stivers & Licheng Sun, 2013. "Market Cycles and the Performance of Relative Strength Strategies," Financial Management, Financial Management Association International, vol. 42(2), pages 263-290, June.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Gao, Li & He, Wei & Wang, Qian, 2019. "In search of distress risk in China's stock market," Global Finance Journal, Elsevier, vol. 42(C).
    2. Richardson, Scott & Tuna, Irem & Wysocki, Peter, 2010. "Accounting anomalies and fundamental analysis: A review of recent research advances," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 410-454, December.
    3. Eero Pätäri & Timo Leivo, 2017. "A Closer Look At Value Premium: Literature Review And Synthesis," Journal of Economic Surveys, Wiley Blackwell, vol. 31(1), pages 79-168, February.
    4. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, April.
    5. de Groot, Wilma & Huij, Joop, 2018. "Are the Fama-French factors really compensation for distress risk?," Journal of International Money and Finance, Elsevier, vol. 86(C), pages 50-69.
    6. Amit Goyal, 2012. "Empirical cross-sectional asset pricing: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(1), pages 3-38, March.
    7. David Hirshleifer, 2001. "Investor Psychology and Asset Pricing," Journal of Finance, American Finance Association, vol. 56(4), pages 1533-1597, August.
    8. Deniz Anginer & Çelim Yıldızhan, 2018. "Is There a Distress Risk Anomaly? Pricing of Systematic Default Risk in the Cross-section of Equity Returns [The risk-adjusted cost of financial distress]," Review of Finance, European Finance Association, vol. 22(2), pages 633-660.
    9. Martin H. Schmidt, 2017. "Trading strategies based on past returns: evidence from Germany," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 31(2), pages 201-256, May.
    10. Dionysia Dionysiou, 2015. "Choosing Among Alternative Long-Run Event-Study Techniques," Journal of Economic Surveys, Wiley Blackwell, vol. 29(1), pages 158-198, February.
    11. Stephen A. Gorman & Frank J. Fabozzi, 2021. "The ABC’s of the alternative risk premium: academic roots," Journal of Asset Management, Palgrave Macmillan, vol. 22(6), pages 405-436, October.
    12. Daniel, Kent & Hirshleifer, David & Teoh, Siew Hong, 2002. "Investor psychology in capital markets: evidence and policy implications," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 139-209, January.
    13. Andreou, Christoforos K. & Lambertides, Neophytos & Panayides, Photis M., 2021. "Distress risk anomaly and misvaluation," The British Accounting Review, Elsevier, vol. 53(5).
    14. YalçIn, Atakan, 2008. "Gradual information diffusion and contrarian strategies," The Quarterly Review of Economics and Finance, Elsevier, vol. 48(3), pages 579-604, August.
    15. Ye, Qing & Turner, John D., 2014. "The cross-section of stock returns in an early stock market," International Review of Financial Analysis, Elsevier, vol. 34(C), pages 114-123.
    16. Nedumparambil, Elizabeth & Bhandari, Anup Kumar, 2020. "Credit risk – Return puzzle: Evidence from India," Economic Modelling, Elsevier, vol. 92(C), pages 195-206.
    17. Amir Amel†Zadeh, 2011. "The Return of the Size Anomaly: Evidence from the German Stock Market," European Financial Management, European Financial Management Association, vol. 17(1), pages 145-182, January.
    18. Menkhoff, Lukas & Sarno, Lucio & Schmeling, Maik & Schrimpf, Andreas, 2012. "Currency momentum strategies," Journal of Financial Economics, Elsevier, vol. 106(3), pages 660-684.
    19. Chen, Sheng-Syan & Wang, Yanzhi, 2012. "Financial constraints and share repurchases," Journal of Financial Economics, Elsevier, vol. 105(2), pages 311-331.
    20. French, Declan & Wu, Yuliang & Li, Youwei, 2016. "Identifying the relative importance of stock characteristics," Journal of Multinational Financial Management, Elsevier, vol. 34(C), pages 80-91.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bla:finmgt:v:37:y:2008:i:3:p:461-484. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Wiley Content Delivery (email available below). General contact details of provider: https://edirc.repec.org/data/fmaaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.