Modeling Risk and Return Framework using Distress Risk: A Conceptual Framework
This research aims to propose extension of existing asset pricing models by including distress risk anomaly to enhance their predictive ability. It explores in detail the shortcomings of existing asset pricing models and deviation between theoretical and empirical evidences. The limitations of Capital Asset Pricing Model (CAPM) lead to the development of various asset pricing models with the inclusion of different risk factors. Our literature survey search found that distress risk is a missing component which has not been included in any asset pricing models. Therefore, this research proposes a risk and return framework with an extension of Fama and French, three-factor model, Cahart model and Fama and French five-factor model. This study justifies the inclusion of distress risk and proposes a measure to evaluate different distress risk models. Our proposed model will be not only be useful for academicians in future empirical testing, investors in developing their investment strategies but will also help regulators to gain beneficial information for policy decisions.