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Leverage and the Cross‐Section of Equity Returns

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  • HITESH DOSHI
  • KRIS JACOBS
  • PRAVEEN KUMAR
  • RAMON RABINOVITCH
Abstract
Building on theoretical asset pricing literature, we examine the role of market risk and the size, book‐to‐market (BTM), and volatility anomalies in the cross‐section of unlevered equity returns. Compared with levered (stock) returns, unlevered market beta plays a more important role in explaining the cross‐section of unlevered equity returns, even after controlling for size and BTM. The size effect is weakened, while the value premium and the volatility puzzle virtually disappear for unlevered returns. We show that leverage induces heteroskedasticity in returns. Unlevering returns removes this pattern, which is otherwise difficult to address by controlling for leverage in regressions.

Suggested Citation

  • Hitesh Doshi & Kris Jacobs & Praveen Kumar & Ramon Rabinovitch, 2019. "Leverage and the Cross‐Section of Equity Returns," Journal of Finance, American Finance Association, vol. 74(3), pages 1431-1471, June.
    • Handle: RePEc:bla:jfinan:v:74:y:2019:i:3:p:1431-1471
    DOI: 10.1111/jofi.12758
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    Cited by:

    1. Chaderina, Maria & Weiss, Patrick & Zechner, Josef, 2022. "The maturity premium," Journal of Financial Economics, Elsevier, vol. 144(2), pages 670-694.
    2. Kuvshinov, Dmitry & Richter, Björn & Zimmermann, Kaspar, 2022. "The shifts and the shocks: bank risk, leverage, and the macroeconomy," Working Paper Series 2672, European Central Bank.
    3. Venmans, Frank, 2021. "The leverage anomaly in U.S. bank stock returns," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 75(C).
    4. Forte, Santiago & Lovreta, Lidija, 2023. "Credit default swaps, the leverage effect, and cross-sectional predictability of equity and firm asset volatility," Journal of Corporate Finance, Elsevier, vol. 79(C).
    5. Filippo Ippolito & Alessandro Villa, 2022. "Levered Returns and Capital Structure Imbalances," Working Paper Series WP 2022-42, Federal Reserve Bank of Chicago.

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