Can Machines Learn Capital Structure Dynamics?
69 Pages Posted: 22 Oct 2019 Last revised: 26 Oct 2021
Date Written: October 25, 2021
Yes, they can! Machine learning models predict leverage better than linear models and identify a broader set of leverage determinants. They boost the out-of-sample R-squared from 36% to 56% over OLS and LASSO. The best performing model (random forests) selects market-to-book, industry median leverage, cash and equivalents, Z-Score, profitability, stock returns, and firm size as reliable predictors of market leverage. More precise target estimation yields a 10%-33% faster speed of adjustment and improves prediction of financing actions relative to linear models. Machine learning identifies uncertainty, cash flow, and macroeconomic considerations among primary drivers of leverage adjustments.
Keywords: Machine Learning, Target Leverage, Speed of Leverage Adjustment, Financing Actions
JEL Classification: G17, G30, G32, C10, C50
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