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The Systematic Risk and Leverage Effect in the Corporate Sector of Pakistan

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  • Mohammed Nishat

    (Institute of Business Administration, Karachi, and at the Applied Economics Research Centre, University of Karachi.)

Abstract

Poor corporate financing policies, non-competitive role of institutional development, a tendency towards the underpricing of initial offering resulted in high levered stocks in Karachi stock market (KSE). The KSE is termed as high risk high return emerging market where investors seek high risk premium Nishat (1999). The leverage is the most important factor which determines the firms risk premium [Zimmer (1990)]. Hamada (1969) and Bowman (1979) have demonstrated the theoretical relationship between leverage and systematic risk. Systematic risk of the leverage firm is equal to the without leverage systematic risk of the firm times one plus the leverage ratio (debt equity). Bowman (1979) established that systematic risk is directly related to leverage and the accounting beta (covariability of a firms’ accounting earnings with the accounting earnings of the market portfolio). One explanation of time-varying stock volatility is that leverage changes as the relative price of stocks and bonds change. Schwert (1989) demonstrated how a change in the leverage of the firm causes a change in the volatility of stock returns. Haugen and Wichern (1975) analysed the relationship between leverage and relative stability of stock value based on actuarial science1 and found that the duration of the debt is an important attribute in assessing the effect of leverage on stock volatility. If the leverage is persistent, or changing over time due to the issuance of additional debt, or if the firms are trying to return back the debt, this will change the risk of holding common stock.

Suggested Citation

  • Mohammed Nishat, 2000. "The Systematic Risk and Leverage Effect in the Corporate Sector of Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 39(4), pages 951-962.
  • Handle: RePEc:pid:journl:v:39:y:2000:i:4:p:951-962
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    References listed on IDEAS

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    1. Steven A. Zimmer, 1990. "Event risk premia and bond market incentives for corporate leverage," Research Paper 9028, Federal Reserve Bank of New York.
    2. Steven A. Zimmer, 1990. "Event risk premia and bond market incentives for corporate leverage," Monograph, Federal Reserve Bank of New York, number 1990erpabmifc, September.
    3. French, Kenneth R. & Schwert, G. William & Stambaugh, Robert F., 1987. "Expected stock returns and volatility," Journal of Financial Economics, Elsevier, vol. 19(1), pages 3-29, September.
    4. Kane, Alex & Marcus, Alan J. & McDonald, Robert L., 1985. "Debt Policy and the Rate of Return Premium to Leverage," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 479-499, December.
    5. Haugen, Robert A & Wichern, Dean W, 1974. "The Elasticity of Financial Assets," Journal of Finance, American Finance Association, vol. 29(4), pages 1229-1240, September.
    6. Schwert, G William, 1989. " Why Does Stock Market Volatility Change over Time?," Journal of Finance, American Finance Association, vol. 44(5), pages 1115-1153, December.
    7. Steven A. Zimmer, 1990. "Event risk premia and bond market incentives for corporate leverage," Quarterly Review, Federal Reserve Bank of New York, issue Spr, pages 15-30.
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    Cited by:

    1. Mohammed Nishat, 2001. "Industry Risk Premia in Pakistan," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 40(4), pages 929-949.

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