Financial Leverage Does Not Cause the Leverage Effect

A. Cevdet Aydemir, Michael F. Gallmeyer () and Burton Hollifield ()

No 263, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: We quantify the effect of financial leverage on stock return volatility in a dynamic general equilibrium economy with debt and equity claims. We study the effects of financial leverage on the market portfolio, and on a small firm with idiosyncratic and market risk. In an economy with both a constant interest rate and constant price of risk, financial leverage generates little variation in stock return volatility at the market level but significant variation at the individual firm level. In an economy with more realistic variation in interest rates and the price of risk, there is significant variation in stock return volatility at the market and firm level. In such an economy, financial leverage has little effect on the dynamics of stock return volatility at the market level. Financial leverage contributes more to the dynamics of stock return volatility for a small firm

Keywords: stock volatility; leverage effect; general equilibrium (search for similar items in EconPapers)
JEL-codes: G10 G12 (search for similar items in EconPapers)
Date: 2006-12-03

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Persistent link: http://EconPapers.repec.org/RePEc:red:sed006:263

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