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Operating Leverage


  • Robert Novy-Marx


I derive and test implications of the operating leverage hypothesis for the cross-section of expected returns. Using a novel measure of operating leverage, I document that operating leverage predicts returns in the cross-section, and that strategies formed by sorting on operating leverage earn significant excess returns. Operating leverage also explains why the value premium is weak and non-monotonic across industries, but strong and monotonic within industries. Intra-industry differences in book-to-market are driven by differences in operating leverage, giving rise to expected return differences. Industry differences in book-to-market are driven by differences in the capital intensity of production unrelated to returns. Copyright 2011, Oxford University Press.

Suggested Citation

  • Robert Novy-Marx, 2011. "Operating Leverage," Review of Finance, European Finance Association, vol. 15(1), pages 103-134.
  • Handle: RePEc:oup:revfin:v:15:y:2011:i:1:p:103-134

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    References listed on IDEAS

    1. Huberman, Gur, 2001. "Familiarity Breeds Investment," Review of Financial Studies, Society for Financial Studies, vol. 14(3), pages 659-680.
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    5. Merton, Robert C, 1987. " A Simple Model of Capital Market Equilibrium with Incomplete Information," Journal of Finance, American Finance Association, vol. 42(3), pages 483-510, July.
    6. Perraudin, William R. M. & Sorensen, Bent E., 2000. "The demand for risky assets: Sample selection and household portfolios," Journal of Econometrics, Elsevier, vol. 97(1), pages 117-144, July.
    7. De Bondt, Werner F. M., 1998. "A portrait of the individual investor," European Economic Review, Elsevier, vol. 42(3-5), pages 831-844, May.
    8. R. S. Uhler & J. G. Cragg, 1971. "The Structure of the Asset Portfolios of Households," Review of Economic Studies, Oxford University Press, vol. 38(3), pages 341-357.
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