Abstract
Empirical research has documented a negative relationship between distress risk and stock returns. This negative risk–return trade-off, known as the distress puzzle, poses a challenge to asset pricing models. In this study, we provide a new explanation of the distress puzzle by considering the effect of arbitrage asymmetry. We find that the negative distress risk–return relation is stronger in stocks that have higher limits of arbitrage. The investors are virtually unable to short sell mispriced high distress risk stocks due to the low supply of lendable stocks from institutions and that arbitrage is costly. In addition, we show that the limits of arbitrage effect is distinct from liquidity effect in explaining the distress puzzle.
Original language | English |
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Pages (from-to) | 3574-3592 |
Number of pages | 19 |
Journal | International Journal of Finance and Economics |
Volume | 28 |
Issue number | 4 |
Early online date | 15 Mar 2022 |
DOIs | |
Publication status | Published - 4 Oct 2023 |
Bibliographical note
Funding Information:China Scholarship Council Funding information
Publisher Copyright:
© 2022 John Wiley & Sons Ltd.
Keywords
- anomalies
- distress risk
- limits of arbitrage
- market efficiency