Evidence from the European stock markets
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School of Business |
Master's thesis
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Date
2019
Department
Major/Subject
Mcode
Degree programme
Finance
Language
en
Pages
61 + 9
Series
Abstract
PURPOSE OF THE STUDY The main purpose of this paper is to study whether it is possible to find distressed glamour stocks from the market, and whether these stocks underperform other glamour. Furthermore the paper studies if it is possible to enhance the returns of a value strategy by being long non-distressed value stocks and short this distressed glamour. The study utilizes Altman Z-score (Altman, 1968 and 2000) and credit rating as measures for distress risk, and compares whether the results look similar between these measures. The paper is based on two competing theories for the value anomaly: Fama and French (1993) risk-factor theory stating that value strategy returns are due to higher distress of value stocks and Lakonishok, Shleifer and Vishny (1994) mispricing theory stating that investor sentiment overprices glamour and underprices value stocks. DATA The data set used is for EuroStoxx600 stocks for a time period from 2009 to 2018. Data for single stocks as well as the EuroStoxx600 index total return is retrieved from Thomson Reuters. The factor portfolio data as well as the risk-free rate is from Kenneth French data library. RESULTS The most important results are that 1. It is possible to find distressed glamour stocks in the market, 2. These distressed glamour stocks underperform other glamour and 3. A distress risk eliminated long/short value strategy performs well even when traditional factor portfolios don't. These results imply that distress risk is priced incorrectly in glamour stocks, and utilizing this mispricing, it is possible to beat the traditional value portfolios. Consistent with Piotroski (2000) and Griffin and Lemmon (2002) the study finds that distress risk elimination increases the returns of a value strategy. Piotroski finds that distress risk eliminated value long portfolio return is 7.4% higher than the plain value portfolio return annually, whereas this paper concludes that the distress risk eliminated long portfolio returns stay similar, but the standard deviation decreases comparing with plain value. Griffin and Lemmon find that non-distressed value long portfolio provides 2.3% annual alphas after controlling for FF3 factors. This paper finds significant annual alphas of 4-5% and it seems that most of this alpha is due to the newly introduced short leg of distressed glamour stocks, since the annual raw return of the distressed glamour portfolio is only 12.4% compared to the plain glamour portfolio 19.1%. Furthermore the distress risk eliminated long/short portfolio beats the plain value long/short portfolio by raw returns (6.0% vs. 3.5% annually) and Sharpe ratios (1.06 vs. 0.39). The study finds that on average 11% of glamour stocks can be considered quite distressed, whereas 13% of value stocks can be considered very robust. This result indicates that the possibility to find distressed glamour is similar than finding non-distressed value. Furthermore the results show that value stocks are more likely to be distressed than glamour (34% vs. 11% distressed) and that the distressed glamour is in fact a better short portfolio compared to non-distressed glamour, since the long/short portfolio return is higher (6.0% vs. 2.7%) and less volatile (5.7% vs. 6.3%) with the distressed short leg. On the other hand the study finds that the distress risk eliminated long/short portfolio performance persists even when traditional factor portfolios suffer from decreasing returns. Lastly, it seems that monthly rebalancing adds value to the distress risk eliminated value strategy in comparison with less frequent trading.Description
Thesis advisor
Torstila, SamiKeywords
value strategy, glamour stock, distress risk, Altman Z, credit rating