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Options, Equity Risks, and the Value of Capital Structure Adjustments

Paul Borochin and Jie Yang

No 2016-097, Finance and Economics Discussion Series from Board of Governors of the Federal Reserve System (U.S.)

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: 2016-10
New Economics Papers: this item is included in nep-cfn and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedgfe:2016-97

DOI: 10.17016/FEDS.2016.097

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