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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

    as
    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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    3. John M. Griffin & Michael L. Lemmon, 2002. "Book-to-Market Equity, Distress Risk, and Stock Returns," Journal of Finance, American Finance Association, vol. 57(5), pages 2317-2336, October.
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    8. Maria Vassalou & Yuhang Xing, 2004. "Default Risk in Equity Returns," Journal of Finance, American Finance Association, vol. 59(2), pages 831-868, April.
    9. Ron Giammarino & Murray Carlson & Adlai Fisher, 2004. "Corporate Investment and Asset Price Dynamics: Implications for Post-SEO Performance," 2004 Meeting Papers 812, Society for Economic Dynamics.
    10. Bhandari, Laxmi Chand, 1988. " Debt/Equity Ratio and Expected Common Stock Returns: Empirical Evidence," Journal of Finance, American Finance Association, vol. 43(2), pages 507-528, June.
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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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