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Persistent Leverage in Portfolio Sorts: An Artifact of Measurement Error?

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  • Michael Mueller

Abstract

Studies such as Lemmon, Roberts and Zender (2008) demonstrate how stable firms’capital structures are over time, and raise the question of whether new theories of capital structure are needed to explain these phenomena. In this paper, I show that trade-off theory-based empirical proxies that are observed with error offer an alternative explanation for the persistence in portfolio-leverage levels. Measurement error noise equal to 80% of the cross-sectional variation in the market to book ratio, coupled with slight mismeasurement of other factors, matches simulated data moments to empirical moments. This suggests that unobserved investment opportunities play an important role in explaining leverage ratios.

Suggested Citation

  • Michael Mueller, 2014. "Persistent Leverage in Portfolio Sorts: An Artifact of Measurement Error?," Staff Working Papers 14-55, Bank of Canada.
    • Handle: RePEc:bca:bocawp:14-55
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    References listed on IDEAS

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    1. Xin Chang & Sudipto Dasgupta, 2009. "Target Behavior and Financing: How Conclusive Is the Evidence?," Journal of Finance, American Finance Association, vol. 64(4), pages 1767-1796, August.
    2. Murray Z. Frank & Vidhan K. Goyal, 2009. "Capital Structure Decisions: Which Factors Are Reliably Important?," Financial Management, Financial Management Association International, vol. 38(1), pages 1-37, March.
    3. Rajan, Raghuram G & Zingales, Luigi, 1995. "What Do We Know about Capital Structure? Some Evidence from International Data," Journal of Finance, American Finance Association, vol. 50(5), pages 1421-1460, December.
    4. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
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    More about this item

    Keywords

    Financial markets; Econometric and statistical methods;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • C18 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Methodolical Issues: General

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