Co-author: Zhi Da, University of Notre Dame
Status: Forthcoming, Journal of Financial and Quantitative Analysis.
Abstract:
This paper provides empirical evidence supporting the view that a sharp rise in a firm’s
default likelihood causes a change in its shareholder clientele. As institutions decrease their
holdings of the firm’s share, trading volume and cost increase; the order imbalance measure
indicates large selling pressure. The resulting liquidity shock leads to a further concession in
the stock price, recovering though, in the subsequent month. Such price recovery explains the first-month abnormal high return earned by stocks with high default likelihood documented in
Vassalou and Xing (2004). The abnormal high return is therefore mostly reward for providing
liquidity when it is most needed rather than compensation for bearing a systematic default risk.
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