Wagner, Herbert S. III, "The Pricing of Bonds in Bankruptcy and Financial Restructuring", Journal of Fixed Income, Vol. 6, No. 1, (June 1996), pp. 40-47.

Introduction: Two attempts have been made to examine the efficiency of the defaulted bond market. In 1977, Jerold Warner compared the pricing of a series of seventy-three railroad bonds from twenty separate railroads (trading between 1926 and 1955) upon bankruptcy filing to their pricing in the bankruptcy plan of reorganization. Warner focuses on deviations from the rule of absolute priority and on whether bonds traded to violations of this rule. He concludes that the capital markets properly price risky bonds to reflect the risk profile of the investment.

The next examination of defaulted debt was not performed until 1992, when Eberhart and Sweeney examined the same issue of efficiency in the defaulted debt market. Eberhart and Sweeney studied 187 bond issues from 74 firms that defaulted between 1980 and 1990. They also conclude that the market for these bonds properly prices all the complexities of the bankruptcy process, an indication of market efficiency.

This examination provides two new additional components to the study of the pricing of defaulted debt. The first new component is the time period: January 1, 1987, through December 31, 1994. Bonds include 461 bond issues from 189 firms.

...The second new component of this examination is the method used to risk-adjust expected returns in the defaulted debt market.