Capital Structure Convergence: Is it Real or Mechanical?
Monash University - Department of Accounting and Finance; Financial Research Network (FIRN)
October 8, 2010
Lemmon et al. (2008) show two features of the data on capital structure: convergence and persistence. I replicate their results and then explore the source of the convergence feature. I show that capital structure convergence is likely to be mechanical rather than real. It sources from a statistical fallacy called the “regression fallacy”. The stationarity of the leverage ratio series and the misclassification problem in portfolio construction give rise to the apparent convergence. Last, I test an implication of the misclassification argument and propose a method that is able to mitigate the mechanical convergence.
Number of Pages in PDF File: 28
Keywords: Capital Structure, The Regression Fallacy, Mechanical Convergence
JEL Classification: G32working papers series
Date posted: October 9, 2010
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