Credit default swaps, the leverage effect, and cross-sectional predictability of equity and firm asset volatility

Santiago Forte, Lidija Lovreta

Research output: Indexed journal article Articlepeer-review

1 Citation (Scopus)

Abstract

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.

Original languageEnglish
Article number102347
Number of pages33
JournalJournal of Corporate Finance
Volume79
DOIs
Publication statusPublished - Apr 2023
EventAnnual Event of Finance Research Letters, 2021 Virtual Conference: Credit default swaps, the leverage effect, and cross-sectional predictability of equity and firm asset volatility - Valencia , Spain
Duration: 5 Jul 20216 Jul 2021

Keywords

  • Asset volatility
  • Capital structure
  • Credit default swaps
  • Cross-sectional predictability
  • Equity volatility
  • Leverage effect

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