Testing the Modigliani-Miller theorem directly in the lab
AbstractWe present an experiment designed to test the Modigliani-Miller theorem. Applying a general equilibrium approach and not allowing for arbitrage among firms with different capital structures, we find that, in accordance with the theorem, participants well recognize changes in the systematic risk of equity associated with increasing leverage and, accordingly, demand higher rate of return. Yet, this adjustment is not perfect: subjects underestimate the systematic risk of low-leveraged equity whereas they overestimate the systematic risk of high-leveraged equity, resulting in a U-shaped cost of capital. A (control) individual decision-making experiment, eliciting several points on individual demand and supply curves for shares, provides some support for the theore
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Bibliographic InfoPaper provided by Friedrich-Schiller-University Jena, Max-Planck-Institute of Economics in its series Jena Economic Research Papers with number 2011-021.
Date of creation: 18 Apr 2011
Date of revision:
Modigliani-Miller theorem; Experiments; Decision making under risk; General equilibrium;
Other versions of this item:
- M. Levati & Jianying Qiu & Prashanth Mahagaonkar, 2012. "Testing the Modigliani-Miller theorem directly in the lab," Experimental Economics, Springer, vol. 15(4), pages 693-716, December.
- G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
- C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-30 (All new papers)
- NEP-CFN-2011-04-30 (Corporate Finance)
- NEP-EXP-2011-04-30 (Experimental Economics)
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