Looking for risk in words: a narrative approach to measuring the pricing implications of financial constraints

We construct a novel measure of financial constraints using textual analysis and investigate its impact on stock returns. Unlike other financial constraints measures, ours is consistent with firm characteristics of constrained firms. We find that constrained firms’ returns move together. The variation of a financial constraints factor cannot be explained by the Fama-French and momentum factors, earning an annualized risk-adjusted excess return of 7%. A stock trading strategy based on financial constraints is most profitable for large and liquid stocks, and when the financial constraints are measured by access to debt markets instead of equity markets.