Market-Clearing Effects of Corporate Financing Decisions on Stock Returns: An Equilibrium Analysis of Levered Firms when Equity Supply is Fixed

47 Pages Posted: 23 Aug 2011 Last revised: 13 Mar 2015

See all articles by Lammertjan Dam

Lammertjan Dam

University of Groningen - Faculty of Economics and Business

Pim Heijnen

University of Groningen

Date Written: March 12, 2015

Abstract

We analyze how corporate financing decisions affect stock returns in a stochastic Ramsey model. Motivated by stylized facts, we incorporate two distinct features in the model. First, the supply of equity (the number of outstanding shares) is fixed. Second, firms pursue a target leverage ratio, and balance retained earnings against new debt issuance when financing real investments accordingly. We characterize both the time-series and cross-sectional properties of equity returns implied by the model and confront these with historical data. The model contains only a few time-invariant parameters, but is able to match many dynamic properties of returns (e.g., fat tails, variation in mean and volatility, mean reversion, time-varying betas, return predictability). Our findings suggest that the leverage effect needs to play a more prominent role in pricing equity.

Keywords: consumption-based asset pricing, general equilibrium, market clearing, return predictability, leverage effect

JEL Classification: C22, D53, G11, G12, G14

Suggested Citation

Dam, Lammertjan and Heijnen, Pim, Market-Clearing Effects of Corporate Financing Decisions on Stock Returns: An Equilibrium Analysis of Levered Firms when Equity Supply is Fixed (March 12, 2015). Available at SSRN: https://ssrn.com/abstract=1914487 or http://dx.doi.org/10.2139/ssrn.1914487

Lammertjan Dam (Contact Author)

University of Groningen - Faculty of Economics and Business ( email )

Postbus 72
9700 AB Groningen
Netherlands
+31-50-3636518 (Phone)

Pim Heijnen

University of Groningen ( email )

P.O. Box 800
9700 AH Groningen, Groningen 9700 AV
Netherlands

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
304
Abstract Views
2,155
Rank
152,256
PlumX Metrics