Leverage and the Cross-Section of Equity Returns
61 Pages Posted: 10 Sep 2014 Last revised: 16 Sep 2018
Date Written: June 22, 2016
Abstract
Building on the 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, the unlevered market beta plays a more important role in explaining the cross-section of unlevered equity returns, even when we control 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.
Keywords: Leverage; unlevered equity returns; asset beta; value premium; size discount; volatility puzzle; heteroskedasticity
JEL Classification: G12
Suggested Citation: Suggested Citation