Financial Leverage and Stock Return Comovement

70 Pages Posted: 12 Nov 2020 Last revised: 20 Jun 2022

See all articles by Hung Xuan Do

Hung Xuan Do

Massey University, Albany campus

Nhut H. Nguyen

Auckland University of Technology

Quan M. P. Nguyen

Massey University

Date Written: September 5, 2020

Abstract

We find that leverage-initiating stocks experience an increase in return comovement with existing leveraged stocks and a decrease in return comovement with existing zero-leverage stocks in the year after the leverage initiation event. In contrast, stocks that fully deleverage comove more with their new peers of zero-leverage stocks and less with their old peers of leveraged stocks. These findings are robust after controlling for common factors and firm characteristics and using various time series and events as exogenous shocks to corporate leverage decisions. The shifts in return comovement are greater for larger absolute leverage changes and distinct from the dividend clientele effect. Our findings can be explained by the financial leverage clientele effect. We find that mutual funds adjust their holdings of leverage changing stocks around the event year and that funds have a propensity to invest their capital flows according to their investors’ preference for leveraged (zero-leverage) stocks.



A new version is forthcoming in the Journal of Financial Markets



Keywords: Leverage, Comovement, Clientele, Style Investment

JEL Classification: G10, G14, G32

Suggested Citation

Do, Hung Xuan and Nguyen, Nhut H. and Nguyen, Quan M. P., Financial Leverage and Stock Return Comovement (September 5, 2020). Journal of Financial Markets, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3687512 or http://dx.doi.org/10.2139/ssrn.3687512

Hung Xuan Do

Massey University, Albany campus ( email )

Auckland
New Zealand
+64 92136160 (Phone)
+64 92136160 (Fax)

HOME PAGE: http://www.massey.ac.nz/massey/expertise/profile.cfm?stref=972450

Nhut H. Nguyen (Contact Author)

Auckland University of Technology ( email )

55 Wellesley St East
Auckland, Auckland 1010
New Zealand
+64 9 921 9999 (Phone)

Quan M. P. Nguyen

Massey University ( email )

Private Bag 11 222
Palmerston North, Manawatu 4442
New Zealand

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