Abstract
We study whether default options are mispriced in equity values by employing a structural equity valuation model that explicitly takes into account the value of the option to default (or abandon the firm) and uses firm-specific inputs. We implement our model on the entire cross section of stocks and identify both over- and underpriced equities. An investment strategy that buys undervalued stocks and shorts overvalued stocks generates an annual four-factor alpha of about 11% for U.S. stocks. The model's performance is stronger for stocks with a higher value of the default option, such as distressed or highly volatile stocks.
Original language | English (US) |
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Pages (from-to) | 845-898 |
Number of pages | 54 |
Journal | Journal of Finance |
Volume | 74 |
Issue number | 2 |
DOIs | |
State | Published - Apr 2019 |
All Science Journal Classification (ASJC) codes
- Accounting
- Finance
- Economics and Econometrics