Presence Of Leverage Research Articles

Determining the Return Volatility of Major Stock Markets Before and During the COVID-19 Pandemic by Applying the EGARCH Model

With this study, we aim to determine the effect of the Covid-19 pandemic on the return volatility of the DJI, the DAX, the FTSE100 and the CAC40 stock indexes. We take return volatility between 1st January 2019 and 17th July 2020 and split it into two separate periods - before the Covid-19 pandemic outbreak and the first wave of the ‘In-Pandemic’ period. Only the so-called first wave of the pandemic was chosen to avoid the influence of knowledge of possible vaccines and antiviral solutions. Data were analysed by using the exponential GARCH (EGARCH) model. Findings show excessive volatility in the major stock markets with short volatility persistence and the presence of leverage in returns during the first wave of the Covid-19 pandemic outbreak. Moreover, during the pandemic period, positive shocks have been observed to have a greater effect than negative socks on the stock index return volatility.

REIT Capital Structure Choices: When Does Preparation Matter?

Pavlov, Steiner and Wachter (2018) find that REITs which prepared by reducing leverage and extending maturity prior to the 2007-2009 financial crisis outperformed their peers during the crisis, a result that holds in the presence of leverage and maturity level controls. While the authors document this finding, they are unable to identify its cause. The recent COVID-related market downturn and subsequent recovery offers a unique opportunity to extend this work and to test for why leverage adjustments before a crisis matter. Specifically, we document that the capital structure adjustments that have strong predictive power for the 2007-2009 financial crisis returns have no impact on the REIT returns during the COVID pandemic of 2020. The relevant difference between the two events is that the 2007-2009 financial crisis was largely predictable, especially for members of the real estate industry, while the COVID pandemic was truly unpredictable. Therefore, preparation prior to the 2007-2009 crisis was seen as a signal for managerial competence, but had no information value during the recent pandemic. In other words, managers are expected to prepare for changes in the external environment if and only if those changes are predictable.

Testing the Validity of Gibrats Law in the Context of Profitability and Leverage

This study seeks to test the validity of Gibrat’s Law of Proportionate Effect for listed firms in Ghana over the period 2008-2017. The study also investigates whether firms’ profitability and leverage affect the validity of Gibrat’s Law. Employing the fixed effects regression technique, the results show that Gibrat’s Law does not hold for all firms when the effect of firm size on growth is directly examined. In the presence of profitability, Gibrat’s Law is valid for both financial and non-financial firms. The findings further observe that, while Gibrat’s Law holds for non-financial firms in the presence of leverage, it is rejected for financial firms. Given the direct and significant impact of size on firm growth, the study concludes that Gibrat’s proposition that the growth rate of a given firm is independent of its size does not hold for listed firms in Ghana. The study discusses relevant recommendations based on the findings.

The tail empirical process for long memory stochastic volatility models with leverage

We consider tail empirical processes of long memory stochastic volatility models with heavy tails and leverage. We study the limiting behaviour of the tail empirical process with both fixed and random levels. We show a dichotomous behaviour for the tail empirical process with fixed levels, according to the interplay between the long memory parameter and the tail index; leverage does not play a role. On the other hand, the tail empirical process with random levels is not affected by either long memory or leverage. The tail empirical process with random levels is used to construct a family of estimators of the tail index, including the famous Hill estimator and harmonic mean estimators. The paper can be viewed as an extension of [21] while the presence of leverage in the model creates additional theoretical problems, the limiting behaviour remains unchanged.

Taxes, Capital Structure Choices, and Equity Value

We use a multitude of tax reforms across the Organisation for Economic Co-Operation and Development (OECD) countries as natural experiments to estimate the market value of the tax benefits of debt financing. We report time-series evidence that tax reforms are followed by large changes in the value of corporate equity. However, the impact of tax reforms is greatly mitigated by the presence of leverage. The value of debt tax savings is greater among top taxpayers, among highly profitable firms, and in countries where tax laws are more strongly enforced. Importantly, the value of debt tax savings is in line with the benchmark implied by a traditional approach.

Estimation of Firms' Market Reputation: A Platform for Pragmatic Progress

This study provides formal theoretical evidence that in presence of leverage, share prices cannot be characterized to be robust proxies for product price premiums that are outcomes of firms' corporate reputations. The formal theoretical model predicts proxies for each of corporate reputation, and product price premiums can be derived from firms' financial statements. In presence of global convexity of relations between reputation estimates, and estimates of prior period product price premiums, constructs proposed for each of price premiums or corporate reputation are predicted to be robust. Perpetuity of regulatory reporting ensures robust constructs that are derived from firms' financial statements have time series properties, absence of which has stunted development of a rich literature that studies reputation of non-financial corporations. In presence of generality or normativeness of the global convexity condition, and allowance for development of reputation constructs that are industry specific, commonality of robustness theory (across industries) is combined with pragmatism of industry specificity. We have then that differences in effects of corporate reputation are comparable across industries.

PORTFOLIO OPTIMIZATION IN AFFINE MODELS WITH MARKOV SWITCHING

We consider a stochastic-factor financial model wherein the asset price and the stochastic-factor processes depend on an observable Markov chain and exhibit an affine structure. We are faced with a finite investment horizon and derive optimal dynamic investment strategies that maximize the investor's expected utility from terminal wealth. To this end we apply Merton's approach, because we are dealing with an incomplete market. Based on the semimartingale characterization of Markov chains, we first derive the Hamilton–Jacobi–Bellman (HJB) equations that, in our case, correspond to a system of coupled nonlinear partial differential equations (PDE). Exploiting the affine structure of the model, we derive simple expressions for the solution in the case with no leverage, i.e. no correlation between the Brownian motions driving the asset price and the stochastic factor. In the presence of leverage, we propose a separable ansatz that leads to explicit solutions. General verification results are also proved. The results are illustrated for the special case of a Markov-modulated Heston model.

Taxes, Capital Structure Choices, and Firm Value

We identify a multitude of reforms across 29 OECD countries from 1981 through 2009 that affected statutory corporate or personal tax rates. We use those tax reforms as natural experiments to estimate the market value of the tax benefits of debt financing. We report time-series evidence that tax reforms are followed by large changes in firm value. However, the impact of tax reforms on value is greatly mitigated by the presence of leverage. Consistent with a tax story, the value of debt tax savings is greater among top tax payers, highly profitable firms, and in countries where tax laws are more strongly enforced. The results are robust to a battery of endogeneity tests.

New Warrant Issues Valuation with Leverage and Noisy Equity Values

The empirical analysis of new warrant issues in the context of a structural model of the firm typically assumes the absence of debt and a perfect equity pricing model. We examine here an approach relaxing these two assumptions. The proposed approach develops simple analytical expressions for the prices of warrant, debt and equity in the presence of leverage. An empirical strategy is proposed to implement the model with equity prices containing model errors. An illustration with a recent warrant issue deal between Bank of America and Berkshire Athaway is provided.

Diagnostic Tests for Transformations

The evidence for transformation of the response in a regression model may sometimes depend crucially on one or a few observations. Expressions are derived for estimating the effect of deletion of observations on both the score test and the estimate of the transformation parameter. The estimates are presented as index plots, which are as easy to calculate as the wellknown added-variable plots of constructed variables. One advantage of the new procedure is that the importance of individual observations is not masked by the presence of leverage. A second is that the plots refer directly to score statistics and parameter estimates, both quantities of prime inferential importance. Examples are given for the power transformation and for the shifted power transformation with unknown origin.