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Black's Leverage Effect is not Due to Leverage

25 Pages Posted: 16 Feb 2011  

Jasmina Hasanhodzic

Babson College - Finance Division

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Date Written: February 15, 2011

Abstract

One of the most enduring empirical regularities in equity markets is the inverse relationship between stock prices and volatility, first documented by Black (1976) who attributed it to the effects of financial leverage. As a company's stock price declines, it becomes more highly leveraged given a fixed level of debt outstanding, and this increase in leverage induces a higher equity-return volatility. In a sample of all-equity-financed companies from January 1972 to December 2008, we find that the leverage effect is just as strong if not stronger, implying that the inverse relationship between price and volatility is not driven by financial leverage.

Keywords: Volatility, Leverage Effect, Return/Volatility Relationship, Time-Varying Expected Return, Behavioral Finance

JEL Classification: G12

Suggested Citation

Hasanhodzic, Jasmina and Lo, Andrew W., Black's Leverage Effect is not Due to Leverage (February 15, 2011). Available at SSRN: https://ssrn.com/abstract=1762363 or http://dx.doi.org/10.2139/ssrn.1762363

Jasmina Hasanhodzic

Babson College - Finance Division ( email )

Babson Park, MA 02457-0310
United States

Andrew W. Lo (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-618
Cambridge, MA 02142
United States
617-253-0920 (Phone)
781 891-9783 (Fax)

HOME PAGE: http://web.mit.edu/alo/www

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

Stata Center
Cambridge, MA 02142
United States

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