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Options, equity risks, and the value of capital structure adjustments

Paul Borochin and Jie Yang

Journal of Corporate Finance, 2017, vol. 42, issue C, 150-178

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.

Keywords: Capital structure; Financial leverage; Options; Implied volatility (search for similar items in EconPapers)
JEL-codes: G30 G32 G12 G14 (search for similar items in EconPapers)
Date: 2017
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Persistent link: https://EconPapers.repec.org/RePEc:eee:corfin:v:42:y:2017:i:c:p:150-178

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