A Behavior Perspective of Distress Anomaly: Evidence From Overnight Returns

Using measurement of overnight returns, this article documents that trading behaviors due to information shocks and investor sentiments contribute to distress anomaly. We find that stocks with the highest (lowest) overnight returns are accompanied with the greatest (smallest) distress risk premium, and accordingly, a conditional distress probability portfolio composed with double sort of overnight returns and distress probability would yield significant profitability. The regression outcomes demonstrate that probability of default significantly interacts with average overnight returns in explaining the future stock returns. The conventional distress anomaly is subsumed by the conditional distress factor, but not vice versa; and only profits of conventional distress-probability portfolios, not of the conditional portfolios, mainly come from stocks with characteristics that are associated with stock mispricing. The empirical results indicate that investors hold distressed stocks longer than expected because positive information shocks occur with high level of information supply and good information quality.