Inter‐industry differences and the impact of operating and financial leverages on equity risk

Ali F. Darrat and Tarun K. Mukherjee

Review of Financial Economics, 1995, vol. 4, issue 2, 141-155

Abstract: Based on the traditional assumption that the degree of combined leverage is strictly a product of operating and financial leverages (DOL and DFL), Mandelker and Rhee (1984) develop an interesting beta decomposition model. Two testable implications of their model, which apply to all firms, are that: (1) changes in DOL and/or DFL should exert a positive impact upon beta; and (2) a negative relationship should hold between DOL and DFL. Huffman (1983), however, questions this multiplicity assumption and, by arguing that a firm's capacity decision is endogenous, posits that an interaction prevails between a firm's DOL and DFL. An implication of Huffman's model is that the relationship between DOL, DFL, and beta depends on a firm's capacity decision and, therefore, may vary across industries. By employing a vector‐autoregressive causality approach, this study finds some evidence in support of Huffman's position.

Date: 1995
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https://doi.org/10.1016/1058-3300(95)90003-9

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Persistent link: https://EconPapers.repec.org/RePEc:wly:revfec:v:4:y:1995:i:2:p:141-155

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