Would You Follow MM or a Profitable Trading Strategy?
We investigate the ability of company capital structures to be used as a predictor for abnormal returns. We carry out robustness tests to determine the predictive ability of debt ratios, controlling for size of company, price-toearnings (PE) ratio, market-to-book value ratio (MTBV) and beta. We show that companies in the lowest leverage decile, exhibit the highest abnormal returns – 17% over a three-year period. A strategy of choosing the smallest companies with the lowest leverage yields cumulative abnormal returns (CARs) in excess of 80% over three years.
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