Do equity covariances reflect financial leverage?

Description

"No arbitrage option pricing theory and the efficient market hypothesis predict that firms with higher financial leverage should have higher equity betas, all else equal. This paper finds little support in the data for this prediction. Within industry, there is large cross sectional variation in financial leverage. However, firms with high (low) financial leverage do not necessarily have high (low) equity beats. In fact, the relationship between equity beta and financial leverage."

Subjects

Series Statement

• Working paper / Division of Research, Harvard Business School -- 03-045