TY - JOUR
T1 - Credit default swaps, the leverage effect, and cross-sectional predictability of equity and firm asset volatility
AU - Forte, Santiago
AU - Lovreta, Lidija
N1 - Funding Information:
Early versions of this paper have been distributed with the title “Implied Asset Volatility in Credit Default Swap Premia,” and “Implied Equity and Firm Asset Volatility in Credit Default Swap Premia.” The authors thank Luca del Viva, Theodosios Dimopoulos, Evgeny Lyandres (the Editor), an anonymous referee and the participants at the ESADE-GREF Seminar, INFINITI Conference on International Finance 2019, EFMA Annual Meeting 2019, AEFIN 27th Finance Forum, Paris Financial Management Conference 2019, 27th Annual Virtual Conference of the MFS, Virtual World Finance Conference 2020, Annual Event of Finance Research Letters 2021 Virtual Conference, and C.R.E.D.I.T. 2022 conference for their helpful comments. Rune Fiskaali Ernst provided valuable assistance in the elaboration of a preliminary database. Financial support from Banco Sabadell, AGAUR—SGR 2017-640, and Grant PID2019-106465GB-I00 funded by MCIN/AEI/ 10.13039/501100011033 is also gratefully acknowledged. The usual disclaimers apply.
Funding Information:
☆ Early versions of this paper have been distributed with the title “Implied Asset Volatility in Credit Default Swap Premia,” and “Implied Equity and Firm Asset Volatility in Credit Default Swap Premia.” The authors thank Luca del Viva, Theodosios Dimopoulos, Evgeny Lyandres (the Editor), an anonymous referee and the participants at the ESADE-GREF Seminar, INFINITI Conference on International Finance 2019, EFMA Annual Meeting 2019, AEFIN 27th Finance Forum, Paris Financial Management Conference 2019, 27th Annual Virtual Conference of the MFS, Virtual World Finance Conference 2020, Annual Event of Finance Research Letters 2021 Virtual Conference, and C.R.E.D.I.T. 2022 conference for their helpful comments. Rune Fiskaali Ernst provided valuable assistance in the elaboration of a preliminary database. Financial support from Banco Sabadell, AGAUR—SGR 2017-640, and Grant PID2019-106465GB-I00 funded by MCIN/AEI/ 10.13039/501100011033 is also gratefully acknowledged. The usual disclaimers apply.
Publisher Copyright:
© 2022 The Authors
PY - 2023/4
Y1 - 2023/4
N2 - Leverage represents both a fundamental component of equity volatility and a long-run selection variable. Based on this premise, we investigate the influence of leverage on the long-run cross-sectional predictability of future realized equity volatility. Leverage makes equity volatility significantly less predictable than underlying firm asset volatility, a result that is robust to different predictors of future realized volatility: credit default swap implied, historical, and option implied volatility. A simple model of optimal capital structure, wherein companies maximize tax benefits subject to a common maximum default probability (minimum credit rating) target, helps explain this finding.
AB - Leverage represents both a fundamental component of equity volatility and a long-run selection variable. Based on this premise, we investigate the influence of leverage on the long-run cross-sectional predictability of future realized equity volatility. Leverage makes equity volatility significantly less predictable than underlying firm asset volatility, a result that is robust to different predictors of future realized volatility: credit default swap implied, historical, and option implied volatility. A simple model of optimal capital structure, wherein companies maximize tax benefits subject to a common maximum default probability (minimum credit rating) target, helps explain this finding.
KW - Asset volatility
KW - Capital structure
KW - Credit default swaps
KW - Cross-sectional predictability
KW - Equity volatility
KW - Leverage effect
UR - http://www.scopus.com/inward/record.url?scp=85150754163&partnerID=8YFLogxK
U2 - 10.1016/j.jcorpfin.2022.102347
DO - 10.1016/j.jcorpfin.2022.102347
M3 - Article
AN - SCOPUS:85150754163
SN - 0929-1199
VL - 79
JO - Journal of Corporate Finance
JF - Journal of Corporate Finance
M1 - 102347
T2 - Annual Event of Finance Research Letters, 2021 Virtual Conference
Y2 - 5 July 2021 through 6 July 2021
ER -