A0865
Title: Re-examining the relation between equity beta and financial leverage
Authors: Chuantai Ju - Rutgers University (United States) [presenting]
Abstract: The purpose is to investigate the relationship between financial leverage and the required return on equity, focusing on both reduced-form and structural beta-leverage specifications. Using high-frequency return data for S\&P 500 stocks between 2007 and 2017, stock beta is estimated via Fama-French factor models, and financial leverage is defined as the ratio of book debt to market equity. In the reduced form, Fama-MacBeth regressions reveal a positive and statistically significant beta-leverage relation in over 74\% of months. To further examine structural validity, a time-series approach is employed to test whether the model-implied unlevered beta $\tilde{\beta}_u$ aligns with the empirically estimated $\hat{\beta}_u$. The structural model incorporates the tax shield and bond risk, decomposing equity beta into operating risk and financial risk components. This framework allows the assessment of whether the Hamada model overstates the penalty of leverage. The results highlight the importance of model assumptions and offer updated insights on the role of leverage in pricing equity risk using recent high-frequency data.
