An Investor Dilemma: Distressed Firms' Common Shares

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This study investigates whether investors can systematically profit by either purchasing or shorting the shares of financially distressed companies. Logistic regression is employed to identify such companies, and in separate iterations, the shares of of the companies are purchased and sold short. Then one-, two-, and three-year holding period returns are calculated. Also investigated is how effective loss-limit orders are in reducing the drag on portfolio returns caused by shares that do not behave in the posited manner. The results of the study indicate that neither strategy works well. Even with loss limits, both the long and short positions earned returns less than the market return for the study period.

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