Leverage bias and risk-return trade-off, evidence from China

Abstract

ABSTRACT This study examines whether the difference between firms’ actual and expected target leverage rAtios affects the cross-sectional risk-return trade-off in the stock market. It uses the financial data of all A-share firms listed and traded on the Shanghai and Shenzhen Stock Exchange from 2000 to 2018 in the CSMAR database. We find that the risk-return relationship is negative when the actual leverage is lower than the target leverage. Conversely, the risk-return relation is positive when the actual leverage is higher than the target leverage. This is contrary to the basic principle that the greater the risk, the higher the return in the traditional financial field.