Distress Risk and Stock Returns in the U.K. Industrials Industry

Abstract

In this dissertation, a dynamic logit model for bankruptcy prediction within the UK Industrials sectors is developed based on Campbell et al (2008) proposal. By investigating different variables, it is evident that market-driven predictors are more dominant in forecasting failure events during the last decade. The study also explores the relation between distress risk and stock returns within the industry. In contrast to most of prior literature on the same topic (Dichev, 1998; Campbell et al, 2008; Agarwal and Taffler, 2008b), the results show that distresses stocks, which have higher probabilities of bankruptcy, outperform non-distressed stocks. More importantly, the study examines closer the link between the firms’ size characteristic and the distress factor to derive profitable investment strategies. Surprisingly to certain extent, its finding suggests that in order to earn higher returns investors should pick stocks of small-sized firms with higher bankrupt probabilities.