The Cross Section of Expected Firm (Not Equity) Returns

Abstract

Using the Lehman Fixed Income Database, this paper provides the first comprehensive study of expected firm (not equity) returns. After accounting for the debt component of the firm return, I find that many of the cross sectional determinants of expected equity and debt returns are nonexistent at the level of the firm. Cross sectional variation in expected firm returns is small relative to expected equity returns. In general, my results suggest that capital structure, not firm level, effects play a major role in understanding many security-specific asset pricing regularities. The emphasis on capital structure effects challenges various firm level rational and irrational theories motivating the book-to-market, short-term momentum, and long-term reversal effects in equity returns.

Keywords: Book-to-market, capital structure, debt returns, equity returns, firm returns, leverage, momentum, reversal

JEL Classification: E44, G12, G14, G32