Using Leverage as a Risk Factor in Explaining the Cross Section of Stock Returns

24 Pages Posted: 4 Mar 2008 Last revised: 22 Jun 2016

Sheeja Sivaprasad

University of Westminster - Westminster Business School

Yaz Gulnur Muradoglu

Queen Mary University of London; City University London - Sir John Cass Business School

Date Written: Feb 2010,

Abstract

Leverage is an important risk factor which has been ignored in the asset pricing literature. This paper attempts to broaden the focus of the current asset pricing literature by forming portfolios mimicking the leverage factor. Leverage is a vital risk factor that explains stock returns. We also undertake several robustness checks. We employ three models of performance measurement including the CAPM, the Fama-French three factor model and Fama- French-Carhart four factor model. We construct a five factor model using an additional factor mimicking portfolio for leverage. Our five factor model explains the variations in stock returns better relative to the other asset pricing models.

Keywords: Leverage, Stock Returns, Capital Structure

JEL Classification: G12, G31, G32

Suggested Citation

Sivaprasad, Sheeja and Muradoglu, Yaz Gulnur, Using Leverage as a Risk Factor in Explaining the Cross Section of Stock Returns (Feb 2010,). Available at SSRN: https://ssrn.com/abstract=1101504 or http://dx.doi.org/10.2139/ssrn.1101504

Sheeja Sivaprasad (Contact Author)

University of Westminster - Westminster Business School ( email )

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Yaz Gulnur Muradoglu

Queen Mary University of London ( email )

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United Kingdom

City University London - Sir John Cass Business School ( email )

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