Options, Equity Risks, and the Value of Capital Structure Adjustments
Abstract: We use exchange-traded options to identify risks relevant to capital structure adjustments in firms. These forward-looking market-based risk measures provide significant explanatory power in predicting net leverage changes in excess of accounting data. They matter most during contractionary periods and for growth firms. We form market-based indices that capture firms' magnitudes of, and propensity for, net leverage increases. Firms with larger predicted leverage increases outperform firms with lower predicted increases by 3.1% to 3.9% per year in buy-and-hold abnormal returns. Finally, consistent with the quality, leverage, and distress risk puzzles, firms with lower predicted leverage increases are riskier but earn lower abnormal returns.
File(s): File format is application/pdf https://www.federalreserve.gov/econresdata/feds/2016/files/2016097pap.pdf
Part of Series: Finance and Economics Discussion Series
Publication Date: 2016-10