The leverage effect in the UK stock market

Patricia L. Chelley-Steeley, James M. Steeley*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

Abstract

This study seeks to explain the leverage in UK stock returns by reference to the return volatility, leverage and size characteristics of UK companies. A leverage effect is found that is stronger for smaller companies and has greater explanatory power over the returns of smaller companies. The properties of a theoretical model that predicts that companies with higher leverage ratios will experience greater leverage effects are explored. On examining leverage ratio data, it is found that there is a propensity for smaller companies to have higher leverage ratios. The transmission of volatility shocks between the companies is also examined and it is found that the volatility of larger firm returns is important in determining both the volatility and returns of smaller firms, but not the reverse. Moreover, it is found that where volatility spillovers are important, they improve out-of-sample volatility forecasts. © 2005 Taylor & Francis Group Ltd.

Original languageEnglish
Pages (from-to)409-423
Number of pages15
JournalApplied Financial Economics
Volume15
Issue number6
DOIs
Publication statusPublished - 15 Mar 2005

Keywords

  • leverage effect
  • UK
  • stock returns
  • return volatility
  • leverage
  • size characteristics
  • UK companies

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