Capital Structure Convergence: Is it Real or Mechanical?

28 Pages Posted: 9 Oct 2010

See all articles by Yangyang Chen

Yangyang Chen

Hong Kong Polytechnic University - Faculty of Business

Date Written: October 8, 2010

Abstract

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.

Keywords: Capital Structure, The Regression Fallacy, Mechanical Convergence

JEL Classification: G32

Suggested Citation

Chen, Yangyang, Capital Structure Convergence: Is it Real or Mechanical? (October 8, 2010). Available at SSRN: https://ssrn.com/abstract=1689713 or http://dx.doi.org/10.2139/ssrn.1689713

Yangyang Chen (Contact Author)

Hong Kong Polytechnic University - Faculty of Business ( email )

9/F, Li Ka Shing Tower
The Hong Kong Polytechnic University
Hong Kong, Hung Hom, Kowloon M923
China

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