New Evidence on Sources of Leverage Effects in Individual Stocks

Published date01 August 2015
AuthorGeoffrey Peter Smith
Date01 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
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:
1See, for example, Pagan and Schwert (1990), Bollerslev, Chou and Kroner (1992), Pagan (1996), and
Engle (2004).
C2015 The Eastern Finance Association 331

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