The Leverage Effect on Stock Returns

34 Pages Posted: 11 Oct 2010

See all articles by Sheeja Sivaprasad

Sheeja Sivaprasad

University of Westminster - Westminster Business School

Yaz Gulnur Muradoglu

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

Orla Gough

University of Westminster - Business School

Roberta Adami

affiliation not provided to SSRN

Date Written: October 10, 2010

Abstract

This paper examines the relation between abnormal stock returns and leverage. Expanding on Modigliani and Miller’s (1958) Proposition II, abnormal returns are estimated using the asset pricing models of Sharpe and Lintner (the traditional Capital Asset Pricing Model, CAPM), of Fama and French and of Carhart. The findings indicate that returns are decreasing in firm leverage. This paper tests this relation empirically with other risk factors and finds that the results remain robust. The results show that leverage is a firm characteristic that loads on a risk factor. This evidence suggests that leverage should be priced as a risk factor and requires adequate incorporation into common asset pricing models.

Keywords: Leverage, Asset Pricing, Stock Returns

Suggested Citation

Sivaprasad, Sheeja and Muradoglu, Yaz Gulnur and Gough, Orla and Adami, Roberta, The Leverage Effect on Stock Returns (October 10, 2010). Available at SSRN: https://ssrn.com/abstract=1690183 or http://dx.doi.org/10.2139/ssrn.1690183

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

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Orla Gough

University of Westminster - Business School ( email )

309 Regent Street
London, W1R 8AL
United Kingdom

Roberta Adami

affiliation not provided to SSRN ( email )

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