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Testing the Modigliani-Miller theorem directly in the lab: a general equilibrium approach

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  • Jianying Qiu

    (Department of Economics, University of Innsbruck SOWI Building, Universitaetstrasse 15 6020 Innsbruck, Austria // Max Planck Institute of Economics, ESI Group, Kahlaische Str. 10, D-07745 Jena, Germany)

  • Prashanth Mahagaonkar

    (Max Planck Institute of Economics, EGP Group, Kahlaische Str. 10, D-07745 Jena, Germany // Schumpeter School of Business and Economics, University of Wuppertal, Germany)

Abstract

In this paper, we directly test the Modigliani-Miller theorem in the lab. Applying a general equilibrium approach and not allowing for arbitrage among firms with different capital structures, we are able to address this issue without making any assumptions about individuals' risk attitudes and initial wealth positions. We find that, consistent with the Modigliani-Miller theorem, experimental subjects well recognized the increased systematic risk of equity with increasing leverage and accordingly demanded higher rate of return. Furthermore, the correlation between the value of the debt and equity is -0.94, which is surprisingly comparable with the -1 predicted by the Modigliani-Miller theorem. Yet, a U shape cost of capital seems to organize the data better.

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Bibliographic Info

Paper provided by Universit├Ątsbibliothek Wuppertal, University Library in its series Schumpeter Discussion Papers with number sdp09006.

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Length: 27
Date of creation: Jun 2009
Date of revision:
Handle: RePEc:bwu:schdps:sdp09006

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Web page: http://elpub.bib.uni-wuppertal.de

Related research

Keywords: The Modigliani-Miller Theorem; Experimental Study; Decision Making under Uncertainty; General Equilibrium;

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