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Levered Returns (2007)
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BibTeX
@MISC{Gomes07leveredreturns,
author = {João F. Gomes and Lukas Schmid},
title = {Levered Returns},
year = {2007}
}
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Abstract
In this paper we revisit the theoretical relation between financial leverage and stock returns in a dynamic world where both the corporate investment and finance decisions are endogenous. We find that the link between leverage and stock returns is more complex than the static textbook examples suggest and will usually depend on the investment opportunities available to the firm. In the presence of financial market imperfections leverage and investment are generally correlated so that highly levered firms are also mature firms with relatively more (safe) book assets and fewer (risky) growth opportunities. We use a quantitative version of our model to generate empirical predictions concerning the empirical relationship between leverage and returns. We test these implications in actual data and find support for them.
Keyphrases
stock return growth opportunity financial market imperfection leverage finance decision empirical prediction levered firm theoretical relation quantitative version financial leverage dynamic world corporate investment book asset static textbook empirical relationship actual data mature firm
