Research Articles

Clientele Change, Liquidity Shock, and the Return on Financially Distressed Stocks

Zhi Daa1 and Pengjie Gaoa2

a1 Mendoza College of Business, University of Notre Dame, Notre Dame, IN 46556. [email protected]

a2 Mendoza College of Business, University of Notre Dame, Notre Dame, IN 46556. [email protected]


We show that the abnormal returns on high default risk stocks documented by Vassalou and Xing (2004) are driven by short-term return reversals rather than systematic default risk. These abnormal returns occur only during the month after portfolio formation and are concentrated in a small subset of stocks that had recently experienced large negative returns. Empirical evidence supports the view that the short-term return reversal arises from a liquidity shock triggered by a clientele change.


We are grateful to Nicholas Barberis, Robert Battalio, Hendrik Bessembinder (the editor), Nicolas Bollen, Nai-fu Chen, Tarun Chordia (AFA discussant), Shane Corwin, Kent Daniel, Darrell Duffie, Andrea Eisfeldt, Larry Glosten, Joel Hasbrouck, Steve Hillegeist, Jennifer Huang, Gergana Jostova (NBER discussant), Ivalina Kalcheva, Leonid Kogan, Bob Korajczyk, Anthony Lynch, Ron Masulis, Mitchell Peterson, Christopher Polk, Todd Pulvino, Ernst Schaumburg, Michael Schill (FMA discussant), Paul Schultz, S. “Vish” Viswanathan, and Robert Whitelaw; and seminar participants at Arizona State University, Columbia University, Lehman Brothers, Northwestern University, New York University, University of California-Irvine, University of Texas at Austin, University of Notre Dame, University of Pennsylvania, Vanderbilt University, the FMA 2005 annual meeting, the NBER market microstructure 2006 conference, and the AFA 2007 annual meeting for their helpful comments. We thank Ravi Jagannathan for guidance and support. We are grateful to John Griffin (the referee), whose comments substantially improved both the content and exposition of the paper. We also thank Tarun Chordia, Kenneth French, Donald Keim, Ananth Madhavan, Luboš Pástor, Maria Vassalou, Wayne Wagner, and Sunil Wahal for making data available. Part of the results in this paper have previously appeared in an unpublished working paper entitled “Default Risk and Equity Return: Macro Effect or Micro Noise.” We are responsible for all remaining errors.