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Title: New evidence on the impact of financial leverage on beta risk: A time-series approach
Authors: Faff, R.W.
Brooks, R.D.
Kee, H.Y. 
Keywords: Beta risk
Leverage adjustment
Time-series relationship
Issue Date: 2002
Citation: Faff, R.W.,Brooks, R.D.,Kee, H.Y. (2002). New evidence on the impact of financial leverage on beta risk: A time-series approach. North American Journal of Economics and Finance 13 (1) : 1-20. ScholarBank@NUS Repository.
Abstract: The traditional estimation of a project's cost of capital often requires leverage adjustments to beta. Several researchers have empirically investigated the relationship between the debt/equity ratio (D/E) and beta implied by such leverage adjustments. Typically, this has involved cross-sectional analysis of a sample of U.S. firms in selected industry classifications. The major contribution of the current study is to extend this evidence by investigating the relationship between financial leverage and beta using a time-series approach. This has several advantages over the cross-sectional approach. Our results reveal that while the estimated unlevered beta produced by the time-series approach is quite close to the theoretically implied unlevered beta, the mean difference between the two measures across our sample of 348 U.S. stocks is highly significant. The analysis also reveals that 30-40% of our full sample rejects a theoretical D/E restriction on the time-series model. Moreover, the results suggest that the restriction is much more likely to be rejected for stocks with high debt/equity ratios, which in general have low unlevered betas. Further, there is a considerable cross-sectional variation in the proportion of these rejections across industry groupings. Accordingly, these results suggest that due care needs to be applied when taking the traditional view of delevering beta risk. © 2002 Elsevier Science Inc. All rights reserved.
Source Title: North American Journal of Economics and Finance
ISSN: 10629408
DOI: 10.1016/S1062-9408(02)00059-1
Appears in Collections:Staff Publications

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