Market Valuation of Bankrupt Firms: Is There an Anomaly?

Several recent articles in the popular press have focused on the market valuation of bankrupt stocks. The apparently unrealistically high positive prices have been pointed out as an indication of potential pricing inefficiency in the market. Such an inference may or may not be warranted if we regard a bankrupt firm's equity as a deep out-of-the-money call option. This study investigates these issues by examining the evidence on the post-bankruptcy behavior of common stocks for a sample of 154 firms. First, we present evidence on the wealth effects of bankruptcy filing on the pre-petition stockholders. The results show that the prepetition stockholders, on average, lost about 70 percent of their value during the bankruptcy period. Second, we examine whether the market valuation of bankrupt stocks is realistic using the Black-Scholes option pricing model. We find that bankrupt stock prices may be realistic for some estimated levels of the Black-Scholes parameters but not for others.