Time-varying risk aversion and capital Structure: An overlooked effect

In this study, we shed light on the significant, yet often overlooked, influence of aggregate time-varying risk aversion on capital structure. Our research, using real consumption expenditures of the Spanish economy, options on the IBEX-35, and a panel data set of Spanish public firms over the period 2007–2020, reveals that market-wide risk aversion significantly slows the speed of adjustment towards target leverage. Our findings not only highlight the interdependence of the Spanish financial and real sectors, but also provide valuable insights about risk aversion as a crucial driver of corporate managers’ decision-making regarding dynamic capital structure. The paper also shows that risk aversion amplifies the effects of adverse uncertainty shocks on the equity cost of capital. By consolidating these findings, our research elucidates the mechanism through which risk aversion negatively impacts aggregate output and investments during recessions.