The effect of firm’s leverage level on stock returns – evidence from multiple regions
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School of Business |
Master's thesis
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Date
2022
Department
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Mcode
Degree programme
Finance
Language
fi
Pages
58
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Abstract
In this paper, I study the effect of leverage level on stock returns. Even though the effect of leverage has been studied for decades, the outcomes of studies have been different. The traditional finance textbooks say that there should be a positive effect on returns when the leverage level rises. This has not been the case in many recent publications as many of them have found out that the effect is in fact the opposite. To study the effect with the most recent data, I perform empirical tests in three different ways. All empirical tests are performed for four different regions which are Asia & Pacific, Europe, the United States, and Japan. The sample period is from 1990 to 2021 and I have excluded the smallest 15% of the firms to avoid the small-cap effect. To calculate the monthly abnormal returns, I use three different asset pricing models which are the Fama-French three-factor model, the Carhart four-factor model, and the Fama-French five-factor model. First, I examine the results when the whole market is considered. For this empirical test, the hypothesis states that in the overall market, high-leverage has a negative effect on stock returns and low-leverage has a positive effect on stock returns. My findings show that Asia & Pacific, Europe, and the United States samples confirm the hypothesis, but the Japanese sample shows insignificant abnormal returns for all portfolios. Second, I study the effect of leverage when considering the concentration level of an industry. The hypothesis states that lower leverage levels have a greater positive effect on stock returns in concentrated industries than in more competitive industries. The results show that the hypothesis was confirmed by the Asia & Pacific sample, as well as the Japan sample. Europe and the United States samples show similar abnormal returns between concentrated and competitive categories and therefore do not confirm the hypothesis. Lastly, I study the effect of leverage in each industry individually. The hypothesis for this empirical test states that higher leverage results in higher abnormal returns in the utilities sector. Lower leverage results in higher abnormal returns in the industrial goods and services sector, as well as in the consumer products and services sector. The results show mixed outcomes as some parts of the hypothesis are confirmed by one or two regions and some parts are not confirmed by any region. To conclude the findings, it can be said that there is not one common way of how leverage affects stock returns in different industries and with different competition levels, as none of the hypotheses were confirmed by all the regions. As this paper adds more extensive results of the leverage effect to the literature, especially the joint effect between the leverage level and industry concentration, it leaves the question open of why there are such differences between the regionsDescription
Thesis advisor
Nyberg, PeterKeywords
leverage, industry concentration, abnormal returns, stocks