In this paper, we revisit the question whether the Fama-French factors are manifestation of distress risk premiums. To this end, we develop new tests specifically aimed at dissecting the Fama-French factor returns from a distress risk premium. While we find that value and small-cap exposures are typically associated with distress risk, our results also indicate that distress risk is not priced and that the small-cap and value premiums are priced beyond distress risk. Moreover, the distress risk exposures of common small-cap and value factors do not have explanatory power in asset pricing tests. Our results are robust to international out-of-sample analyses and have important implications for investors engaging in small-cap and value strategies.

Additional Metadata
Keywords Bankruptcy, Bond spread, Book-to-market effect, Credit rating, Credit spread, Default risk, Distress risk, Market efficiency, Small-cap effect, Value anomaly
JEL Portfolio Choice; Investment Decisions (jel G11), Asset Pricing (jel G12), Information and Market Efficiency; Event Studies (jel G14)
Persistent URL dx.doi.org/10.1016/j.jimonfin.2018.03.002, hdl.handle.net/1765/106354
Journal Journal of International Money and Finance: theoretical and empirical research in international economics and finance
Citation
de Groot, W.A, & Huij, J.J. (2018). Are the Fama-French factors really compensation for distress risk?. Journal of International Money and Finance: theoretical and empirical research in international economics and finance, 86, 50–69. doi:10.1016/j.jimonfin.2018.03.002