Abstract
AbstractThe Black’s leverage effect hypothesis postulates that a negative stock return innovation increases the financial leverage of a firm since the value of equity decreases at a given level of debt, which, in turn, creates a higher equity return volatility in the future. The paper is aimed at investigating the authenticity of the Black’s leverage effect hypothesis and the relationship between negative stock returns and the financial leverage of the UK oil and gas stocks from 2004 to 2015. For each stock, exponential generalised autoregressive conditional heteroscedasticity model was estimated using Fama–French–Carhart 4-factor asset pricing model to extract the difference between the effects of negative and positive stock return innovations, regarded as leverage effect. The leverage effect parameter was further regressed on the financial leverage ratios of the book value of long-term debt to total assets, interest expenses to total assets and long-term debt to market value of equity to examine whether...
Highlights
The Black (1976)’s leverage effect hypothesis postulated an inverse relationship between stock returns and future volatility, and if stock returns are negative, equity value decreases and leverage increases given a fixed level of debt in company’s capital structure (Hasanhodzic & Lo, 2011)
The causes of volatility asymmetry have been traced to trading activity that has been guided by information asymmetry between well informed and uninformed investors in the market, (Avramov, Chordia, & Goyal, 2006), and market-wide factors such as market-level volatility innovations, market-wide cash flows, market-level leverage and world’s stock return as suggested by Dennis, Mayhew, and Stivers (2006)
The Nelson (1991)’s exponential generalised autoregressive conditional heteroscedasticity (EGARCH) model was estimated on the individual excess stock returns of the UK oil companies using FamaFrench and momentum factors to extract the Black’s leverage effect
Summary
The Black (1976)’s leverage effect hypothesis postulated an inverse relationship between stock returns and future volatility, and if stock returns are negative, equity value decreases and leverage increases given a fixed level of debt in company’s capital structure (Hasanhodzic & Lo, 2011). Financial leverage was identified to be responsible for volatility asymmetry Scholars such as Smith (2015) have observed the weaknesses of the findings of Christie (1982) to include the use of homoscedasticity assumption in modelling stock returns. The argument of whether the level of a financial leverage in a company contributes to the established volatility asymmetry or leverage effect in its stock returns continues, with scholars such as Smith (2015) supporting the argument, and scholars such as Hasanhodzic and Lo (2011) opposing the position. Many approaches have been adopted by scholars to measure the leverage effect in stock returns and its determinants but very little evidence of the use of 4-factor pricing model in such analyses was found in the literature (Bekaert & Wu, 2000; Christie, 1982; Daouk & Ng, 2011; Duffee, 1995; Hasanhodzic & Lo, 2011; Smith, 2015)
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