Strategies · Library · Distressed assets
§15.3Factor
Distress risk puzzle
Firms more likely to go bankrupt have tended to earn lower, not higher, returns. Buy the safest firms and sell the riskiest, ranked by a modelled bankruptcy probability, with monthly or yearly rebalance.
Open in the builderAs a long-only proxy; see how ARCANE uses it.
- Asset class
- Distressed assets
- Held for
- Months
- Data
- ARCANE has part of the data
- Symphony
- Builds as a long-only proxy
The rule
- Signal
- Estimated probability of bankruptcy per stock, for example from a logistic regression
- Entry and exit
- Buy the safest decile and sell the riskiest, rebalance monthly or yearly
- Sizing
- Equal weight within each leg, dollar neutral
How it fails
- Short leg is costly and can squeeze
- Beta swings after crashes
- Needs fundamentals
Data it needs
- company fundamentals
- stock prices
- bankruptcy history
Has stock prices but no fundamentals to model bankruptcy.
How ARCANE uses it
A Call on a leveraged name could cite the low-return record of risky balance sheets. Paper only.
Builds as a long-only proxy. Long-only proxy: keep the lowest-volatility large caps as a stand-in for healthy firms; the bankruptcy score and short leg are dropped.
Filed under the factor card
Own companies that are small, cheap, profitable and invest conservatively, against their opposites, and rebalance once a year.
A paper plan from this card holds 63 to 365 days, stops at 2× the expected move and uses at most 75% of your risk budget. The card
Source: Kakushadze and Serur (2018), 151 Trading Strategies, §15.3, p. 110 of the SSRN version. Described in our words. Factor is ARCANE’s filing, not the book’s.