Abstract
The CAPM is consistent with bankruptcy and limited liability, but only if expected dividends and required rates of return take into account the possibility of bankruptcy. I argue, in this paper, that traditional measures of systematic risk and expected returns are flawed in this regard, and describe the adjustments needed in order for these measures to capture bankruptcy risk. In this process, I lay down a rationale for distress-related CAPM anomalies. The analysis leads to maximum likelihood estimators for bankruptcy risk and cyclicality implicit in stock return distributions, and delineates a unique role for accrual accounting data in valuation.
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