Stock Comovement and Financial Flexibility
34 Pages Posted: 25 Oct 2019
Date Written: October 16, 2019
We develop a dynamic model of corporate investment and financing, in which shocks to the value of collateralizable corporate real estate assets generate variation in firms' debt capacity. We show that the degree of similarity among firms' financial flexibility forecasts cross-sectional variation in return correlation. We test the implications of the model and find that the correlation among stocks in the top-percentile portfolio according to the similarity of financial flexibility is 1.5% higher than the correlation among stocks in the median portfolio. This link is stronger for firms with more investment opportunities, for older firms, and during periods of increasing real estate prices. Our results are robust to multivariate analyses that control for exposure to systematic return factors and several dimensions of similarity across firms.
Keywords: Return Comovement, Financial Flexibility, Real Estate Assets, Collateral
JEL Classification: G12, G32, R3
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