Marcelo Verdini Maia

Ph.D. Candidate in Finance

 

 

 

On the Relation between Financial Leverage and Stock Returns (job market paper): coming soon

 

Financial leverage should be positively related to expected equity returns. However, empirical evidence suggests this is not true. In this paper I decompose expected equity returns according to their exposure to cash flow and discount rate risk. I find that firms with low leverage have lower cash-flow risk and higher discount rate risk than firms with high leverage. Since cash flow risk typically has a higher price of risk, this finding helps to explain the financial leverage puzzle. I then investigate the determinants of risk exposures and the link to capital structure. I show that low leverage firms are more exposed to news about distress costs, debt capacity, and news about the economy wide credit spread, which generally increase sensitivity to market´s discount rate news. Conversely high leverage firms are more exposed to news about default probabilities and profitability, which seem more closely connected to innovations in market cash flow.