Abstract
Distress in the financial sector affects businesses in the corporate sector by spilling over into financing channels. This creates problems for businesses which rely heavily on a continuous supply of funding. These businesses are forced to bypass positive NPV projects when the quantity of available financing in the economy dries up. This reliance on external funding creates risks for businesses. Using two proxies, we explore whether this risk is priced in the cross section of stock returns. While the first proxy measures a firm's reliance on external financing, the second proxy measures a firm's exposure to downside risk in the financial sector. Ex-ante, we expect these proxies to capture similar effects, and to generate a positive premium in the cross-section of returns. As expected, we find that reliance on external finance carries a significantly positive premium. In contrast, however, we find that exposure to downside risk in the financial sector is associated with a significantly negative. High exposure to downside risk in the financial sector generates a discount when compared to assets with low exposure. This effect is robust to controls for other factors known to generate negative premia in the cross section. We find preliminary evidence indicates that this puzzling negative premium may be created by a “bailout discount”.
Published Version
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