New Evidence on Sources of Leverage Effects in Individual Stocks

• DOI: http://doi.org/10.1111/fire.12069
• Published date: 01 August 2015
• Author: Geoffrey Peter Smith
• Date: 01 August 2015

The Financial Review 50 (2015) 331–340

New Evidence on Sources of Leverage

Effects in Individual Stocks

Geoffrey Peter Smith

Arizona State University

Abstract

I test Black’sleverage effect hypothesis on a panel of U.S. stocks from 1997 to 2012. I find

that negative stock return innovations increase the future volatility of equity returns by about

36% more than positive ones. There is a strong and positive relation between variation in the

size of these leverage effects and variation in the firm’s use of debt. I uncover this relation by

applying the Fama/French/Carhart 4-factor asset pricing model in the exponential generalized

autoregressive conditional heteroskedasticity mean equation and by using panel data to control

for firm- and time-invariant unobservables via firstdifferences and two-way fixed effects.

Keywords: l everage effect, EGARCH, volatility, panel data

JEL Classifications: G12, G17, G19

1. Introduction

It is well-known that negativestock return innovations increase the future volatil-

ity of equity returns more than positive ones.1Black (1976) is widely credited as the

first to document this phenomenon and attribute it to financial leverage. According

Corresponding author: Department of Finance, WP Carey School of Business, Arizona State University,

Tempe, AZ 85287; Phone: (480) 965-8623; Fax: (480) 965-8539; E-mail: gps@asu.edu.

1See, for example, Pagan and Schwert (1990), Bollerslev, Chou and Kroner (1992), Pagan (1996), and

Engle (2004).

C2015 The Eastern Finance Association 331