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Department of Business and Management Science, Norwegian School of Economics (NHH) Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)

No 2006/8:
Financial Distress and Idiosyncratic Volatility: An Empirical Investigation

Jing Chen () and Lorán Chollete ()

Abstract: We address the twin puzzles of anomalously low returns for high idiosyncratic volatility and high distress risk stocks, documented by Ang, Hodrick, Xing and Zhang (2006) and Campbell, Hilscher and Szilagyi (2005), respectively. We accomplish two objectives in this study. First, we investigate the link between idiosyncratic volatility and distress risk and find that the idiosyncratic volatility effect exists only conditionally on high distress risk. Second, using a corrected single-beta CAPM model, we provide a rational explanation for the twin puzzles. Joint statistical tests cannot reject the null hypothesis of zero abnormal returns across the idiosyncratic volatility and distress risk portfolios, for the corrected model.

Keywords: Distress risk; idiosyncratic volatility; single-beta CAPM; (follow links to similar papers)

JEL-Codes: C12; (follow links to similar papers)

27 pages, August 4, 2006

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