The variance risk premium and capital structure

Arbeitspapier

This paper investigates how the asset-return variance risk premium changes leverage. I find that the premium lowers leverage by increasing risk-neutral bankruptcy probability and costs in a model where asset returns have stochastic variance with risk premium. Empirically, the model calibrations verify significant reduction in optimal leverage, closer to observed leverage than the model without the premium. In model-free regressions, I also document negative correlation between leverage and the variance premium. The most negative correlation is among investment-grade firms with low asset beta and historical variance but high variance premium because their assets have high exposure to market variance premium.

Object Details

• ISBN: 978-92-9472-022-1
• Language: Englisch

References and Relationships

• Bibliographic citation: Series: ESRB Working Paper Series ; No. 70

Classification and Topics

• Classification: Wirtschaft ; Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill ; Bankruptcy; Liquidation ; Asset Pricing; Trading Volume; Bond Interest Rates
• Subject: Variance Risk Premium ; Capital Structure ; Optimal Leverage

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Lotfaliei, Babak
• Event: Veröffentlichung
• (who): European Systemic Risk Board (ESRB), European System of Financial Supervision
• (where): Frankfurt a. M.
• (when): 2018

Further information

• DOI: doi:10.2849/840761
• Handle: http://hdl.handle.net/10419/193577
• Last update: 10.03.2025, 11:43 AM CET