The impact of financial leverage on the variance of stock returns

David Yechiam Aharon, Yossi Yagil

    Research output: Contribution to journalArticlepeer-review

    Abstract

    This paper investigates the direct theoretical relationship between the variance of stock returns (σ2 E) and financial leverage (L) considering both corporate and personal taxes. Using a dataset of U.S. industrial firms, we examine the variance of stock returns as a function of the firm’s financial leverage. We demonstrate that (1) the variance of stock returns is positively related to the firm’s financial leverage, (2) the relationship between the variance of stock returns and financial leverage is positive when corporate and personal taxes are also considered, and (3) with regard to the relationship between the variance of stock returns and financial leverage, using market measures of the latter tends to generate a higher coefficient of determination and a more accurate approximation of the theoretical relationship between financial leverage and the variance of stock returns.

    Original languageEnglish
    Article number14
    JournalInternational Journal of Financial Studies
    Volume7
    Issue number1
    DOIs
    StatePublished - Mar 2019

    Bibliographical note

    Funding Information:
    We would like to thank the seminar participants at the University of Haifa for their comments and suggestions on an earlier draft of the paper. Remaining errors are our responsibility.

    Publisher Copyright:
    © 2019 by the authors. Licensee MDPI, Basel, Switzerland.

    Keywords

    • Corporate taxes
    • Financial leverage
    • Market imperfections
    • Personal taxes
    • Volatility

    ASJC Scopus subject areas

    • Finance

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