The Pricing of Size, Book to Market and Financial Leverage in Euro Stocks

Nawazish Mirza, Mawal Sara Saeed and Kumail Abbas Rizvi

Economic Research-Ekonomska Istraživanja, 2013, vol. 26, issue 2, 177-190

Abstract: The relevance of financial leverage in a firm's capital structure holds great significance, however its role in asset pricing remains under investigated. In this paper we investigate if financial leverage is priced employing a sample of listed equities from nine European Union countries spanning over a period of twenty years (1989 - 2008). We form size, book to market, and leverage portfolios, to examine if leverage premium is systematic and whether augmenting the three factor model by including leverage variable would better explain the portfolio returns. Moreover, the paper investigates if size and value will capture financial distress in the presence of a superior measure based on net leverage. Our results suggest that the explanatory power of a four factor model is substantially superior to the "vanilla" version of a three factor model. Despite significant size and book to market coefficients, we could not find evidence that size and book to market factor capture financial distress in presence of a leverage mimicking factor.

Date: 2013
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DOI: 10.1080/1331677X.2013.11517615

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