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Levered Returns

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  • JOAO F. GOMES
  • LUKAS SCHMID

Abstract

This paper revisits the theoretical relation between financial leverage and stock returns in a dynamic world where both corporate investment and financing decisions are endogenous. We find that the link between leverage and stock returns is more complex than static textbook examples suggest, and depends on the investment opportunities available to the firm. In the presence of financial market imperfections, leverage and investment are generally correlated so that highly levered firms are also mature firms with relatively more (safe) book assets and fewer (risky) growth opportunities. A quantitative version of our model matches several stylized facts about leverage and returns.

Suggested Citation

  • Joao F. Gomes & Lukas Schmid, 2010. "Levered Returns," Journal of Finance, American Finance Association, vol. 65(2), pages 467-494, April.
    • Handle: RePEc:bla:jfinan:v:65:y:2010:i:2:p:467-494
    DOI: 10.1111/j.1540-6261.2009.01541.x
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    File URL: https://doi.org/10.1111/j.1540-6261.2009.01541.x
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    References listed on IDEAS

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    1. Joao Gomes & Leonid Kogan & Lu Zhang, 2003. "Equilibrium Cross Section of Returns," Journal of Political Economy, University of Chicago Press, vol. 111(4), pages 693-732, August.
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    13. Ivo Welch, 2004. "Capital Structure and Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 112(1), pages 106-131, February.
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