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An additional analysis of estimation techniques for the degree of financial leverage

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  • Steven Stelk
  • Sang‐Hyun Park
  • Simon Medcalfe
  • Michael T. Dugan

Abstract

This study compares three different empirical proxies for the financial leverage component of a systematic risk‐composition model employed in prior financial research. We consider one static accounting measure and two elasticity‐based measures. We find that the traditional static accounting measure of financial leverage provides statistically different estimates of financial leverage when compared to estimates from elasticity‐based measures of the degree of financial leverage. The findings are important because the elasticity‐based models for the degree of financial leverage have clear theoretical links to market‐based models of systematic risk, while the static accounting measure of financial leverage does not. Practitioners and researchers should carefully consider why they are estimating financial leverage and choose the appropriate method for doing so given the goals and potential consequences for biased estimation.

Suggested Citation

  • Steven Stelk & Sang‐Hyun Park & Simon Medcalfe & Michael T. Dugan, 2018. "An additional analysis of estimation techniques for the degree of financial leverage," Review of Financial Economics, John Wiley & Sons, vol. 36(3), pages 220-231, July.
    • Handle: RePEc:wly:revfec:v:36:y:2018:i:3:p:220-231
    DOI: 10.1016/j.rfe.2017.03.005
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    References listed on IDEAS

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    1. Steven Stelk & Sang Hyun Park & Michael T Dugan, 2015. "An additional analysis on operating leverage estimation methods," Journal of Financial Economic Policy, Emerald Group Publishing Limited, vol. 7(2), pages 180-188, May.
    2. Mandelker, Gershon N. & Rhee, S. Ghon, 1984. "The Impact of the Degrees of Operating and Financial Leverage on Systematic Risk of Common Stock," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(1), pages 45-57, March.
    3. Dugan, Michael T & Shriver, Keith A, 1992. "An Empirical Comparison of Alternative Methods for the Estimation of the Degree of Operating Leverage," The Financial Review, Eastern Finance Association, vol. 27(2), pages 309-321, May.
    4. Hill, Ned C. & Stone, Bernell K., 1980. "Accounting Betas, Systematic Operating Risk, and Financial Leverage: A Risk-Composition Approach to the Determinants of Systematic Risk," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 15(3), pages 595-637, September.
    5. Hamada, Robert S, 1972. "The Effect of the Firm's Capital Structure on the Systematic Risk of Common Stocks," Journal of Finance, American Finance Association, vol. 27(2), pages 435-452, May.
    6. Lev, Baruch, 1974. "On the Association between Operating Leverage and Risk," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 9(4), pages 627-641, September.
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    Cited by:

    1. Tibor Tarnóczi & Edit Veres & Edina Kulcsár, 2021. "Financial And Operating Risk Analysis Of Two Romanian-Hungarian Border Counties," Annals of Faculty of Economics, University of Oradea, Faculty of Economics, vol. 1(1), pages 242-250, July.

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