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Board of Governors of the Federal Reserve System (US)
Finance and Economics Discussion Series
Options, Equity Risks, and the Value of Capital Structure Adjustments
Paul Borochin
Jie Yang
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.


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Paul Borochin & Jie Yang, Options, Equity Risks, and the Value of Capital Structure Adjustments, Board of Governors of the Federal Reserve System (US), Finance and Economics Discussion Series 2016-097, Oct 2016.
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Keywords: Capital Structure ; Financial Leverage ; Options ; Implied Volatility
DOI: 10.17016/FEDS.2016.097
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