Stock Comovement and Financial Flexibility

52 Pages Posted: 25 Oct 2019 Last revised: 27 Feb 2021

See all articles by Teng Huang

Teng Huang

Luiss Guido Carli University - Department of Economics and Finance

Anil Kumar

Aarhus University, Department of Economics & Business Economics; Danish Finance Institute

Stefano Sacchetto

IESE Business School

Carles Vergara-Alert

University of Navarra - IESE Business School

Date Written: February 21, 2021

Abstract

We develop a dynamic model of corporate investment and financing, in which shocks to the value of collateralizable 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 with firm-level data in two separate empirical analyses using: (i) an instrumental variable approach based on shocks to the value of collateralizable corporate assets and (ii) the outbreak of the COVID-19 crisis as an event study. We find that firms in the same percentile of the cross-sectional distribution of financial flexibility have 62% higher correlation in stock return residuals than firms that are 50 percentiles apart.

Keywords: Return Comovement, Financial Flexibility, COVID-19

JEL Classification: G12, G32

Suggested Citation

Huang, Teng and Kumar, Anil and Sacchetto, Stefano and Vergara-Alert, Carles, Stock Comovement and Financial Flexibility (February 21, 2021). Available at SSRN: https://ssrn.com/abstract=3470759 or http://dx.doi.org/10.2139/ssrn.3470759

Teng Huang

Luiss Guido Carli University - Department of Economics and Finance ( email )

Viale Romania, 32
Rome, 00197
Italy

Anil Kumar (Contact Author)

Aarhus University, Department of Economics & Business Economics ( email )

Fuglesangs Alle 4
Aarhus V, 8210
Denmark

Danish Finance Institute ( email )

Stefano Sacchetto

IESE Business School ( email )

08034 Barcelona
Spain
+34 93 253 6461 (Phone)

Carles Vergara-Alert

University of Navarra - IESE Business School ( email )

Av. Pearson 21
Barcelona, 08034
Spain
+34 932544200 (Phone)
+34 932534343 (Fax)

HOME PAGE: http://web.iese.edu/cvergara/

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