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What Do Credit Markets Tell Us About the Speed of Adjustment?

47 Pages Posted: 15 Feb 2012 Last revised: 22 Jan 2013

Redouane Elkamhi

University of Toronto - Rotman School of Management

Raunaq S. Pungaliya

Sungkyunkwan University (SKK) Graduate School of Business

Anand M. Vijh

University of Iowa - Department of Finance

Date Written: January 2013

Abstract

This article proposes a methodology to infer investors’ expectations about the speed at which firms adjust to their target leverage. We find that in the long run bond and CDS investors expect leverage to converge towards a target as suggested by the tradeoff theory. On average, the credit markets imply a fairly rapid annual speed of adjustment of 26%. However, we also find strong support that in the short run the expected adjustment process implicit in the prices of credit instruments is affected by transaction costs, pecking order, and market timing. Overall, we show that one can learn about capital structure speed of adjustment not just from realized leverage changes, but also from expectations embedded in market prices.

Keywords: Target leverage, tradeoff theory, speed of adjustment, pecking order, market timing, bond pricing

JEL Classification: G32, G12

Suggested Citation

Elkamhi, Redouane and Pungaliya, Raunaq S. and Vijh, Anand M., What Do Credit Markets Tell Us About the Speed of Adjustment? (January 2013). Available at SSRN: https://ssrn.com/abstract=2004753 or http://dx.doi.org/10.2139/ssrn.2004753

Redouane Elkamhi

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada

Raunaq S. Pungaliya

Sungkyunkwan University (SKK) Graduate School of Business ( email )

53 Myeongnyun-dong 3-ga Jongno-ju
Guro-gu
Seoul, 110-745
Korea, Republic of (South Korea)

Anand M. Vijh (Contact Author)

University of Iowa - Department of Finance ( email )

Iowa City, IA 52242-1000
United States
319-335-0921 (Phone)
319-335-3609 (Fax)

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