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Financially Constrained Stock Returns
Author(s) -
LIVDAN DMITRY,
SAPRIZA HORACIO,
ZHANG LU
Publication year - 2009
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2009.01481.x
Subject(s) - dividend , debt , monetary economics , earnings , stock (firearms) , collateral , economics , equity (law) , business , portfolio , leverage (statistics) , financial economics , finance , mechanical engineering , political science , law , engineering , machine learning , computer science
We study the effect of financial constraints on risk and expected returns by extending the investment‐based asset pricing framework to incorporate retained earnings, debt, costly equity, and collateral constraints on debt capacity. Quantitative results show that more financially constrained firms are riskier and earn higher expected stock returns than less financially constrained firms. Intuitively, by preventing firms from financing all desired investments, collateral constraints restrict the flexibility of firms in smoothing dividend streams in the face of aggregate shocks. The inflexibility mechanism also gives rise to a convex relation between market leverage and expected stock returns.