Risky Business - Modelling Distress on the Swedish Market

University essay from Lunds universitet/Nationalekonomiska institutionen

Abstract: Financial distress is costly for a company and affects many stakeholders. Although models of distress and default have been constructed and developed by researchers for a long time, a model adapted to the unique characteristics of the Swedish market is still missing. This study has two major purposes: (1) to construct a model of distress on the Swedish market, and (2) to use this model to investigate the existence of a distress risk premium. The sample consisted of companies listed on Nasdaq Stockholm’s Large- and Mid Cap lists in 2007. Companies with a credit rating were used for model construction while non-rated companies were used for model application and to investigate the distress risk premium. The model was of the ordered probit type and was constructed using variables and ratios known to explain distress. The model was then applied by estimating credit ratings of the non-rated companies and then constructing portfolios of companies with the highest and lowest credit risk respectively. The stock returns of these portfolios were compared in order to investigate the existence of a distress risk premium. The result of this study is a model with eight significant variables measuring profitability, leverage, short-term liquidity, relative size, excess return, market-to-book value, share price and volatility. The significance of the variables confirms their adequacy in explaining financial distress. Moreover, this study does not find a significant distress risk premium but further research on the area is required.

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