Liquidity Risk and Distressed Equity

Mamdouh Medhat

Research output: Contribution to conferencePaperResearchpeer-review


I show theoretically and empirically that cash holdings can help rationalize the low returns to distressed equity. In my model, levered firms with financing constraints optimally choose their cash holdings to eliminate liquidity risk and optimally default when insolvent. Using data on solvency, liquidity, and returns for US firms, I find evidence consistent with the model’s predictions: (1) In all solvency levels, the average firm holds enough liquid assets to cover its short-term liabilities; less solvent firms have (2) a higher fraction of their total assets in liquid assets and therefore (3) lower conditional betas and (4) lower returns; (5) the profits of long-short solvency strategies are highest among firms with low liquidity; and (6) the profits of long-short liquidity strategies are highest among firms with low solvency.
Original languageEnglish
Publication date2014
Number of pages51
Publication statusPublished - 2014
EventThe 12th International Paris December Finance Meeting - Paris, France
Duration: 18 Dec 201418 Dec 2014
Conference number: 12


ConferenceThe 12th International Paris December Finance Meeting
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