Return Dynamics of Distressed Bonds

Abstract

This study adds to the small, but growing, body of research on active management of distressed debt. The analysis stratifies the distressed debt universe in various ways to test whether certain subgroups exhibit comparatively low risk or comparatively high returns, thereby representing superior investment opportunities. A small group of distressed bonds rated double-B do provide statistically lower default rates and higher bear market returns than single-B or triple-C issues. The authors also find no comparable advantages for bonds issued by public companies over bonds issued by private companies, which challenges the prevailing investor preference for public companies. And contrary to popular belief, agency ratings do appear to provide information content in the speculative grade market.