Options, Equity Risks, and the Value of Capital Structure Adjustments
63 Pages Posted: 17 Nov 2013 Last revised: 17 Nov 2016
Date Written: October 29, 2016
We use exchange-traded options to identify risks relevant to capital structure adjustments in firms. These forward-looking market-based risk measures provide significant explanatory power in predicting net leverage changes in excess of accounting data. They matter most during contractionary periods and for growth firms. We form market-based indices that capture firms' magnitudes of, and propensity for, net leverage increases. Firms with larger predicted leverage increases outperform firms with lower predicted increases by 3.1% to 3.9% per year in buy-and-hold abnormal returns. Finally, consistent with the quality, leverage, and distress risk puzzles, firms with lower predicted leverage increases are riskier but earn lower abnormal returns.
Keywords: Capital Structure, Financial Leverage, Options, Implied Volatility
JEL Classification: G30, G32, G12, G14
Suggested Citation: Suggested Citation