Article ID | Journal | Published Year | Pages | File Type |
---|---|---|---|---|
960043 | Journal of Financial Economics | 2008 | 21 Pages |
Abstract
Trade-off models commonly invoke financial transaction costs in order to explain observed leverage fluctuations. This paper offers an alternative explanation based on real options. The model is frictionless on the financing side but incorporates irreversibility and fixed costs of investment. Results obtained from simulating the model are broadly consistent with observed financing patterns. Market leverage ratios are negatively related to profitability, mean-reverting, and depend on past stock returns. The gradual and lumpy leverage adjustments can occur in the absence of financial transaction costs. This evidence shows that incorporating real frictions into structural models increases their explanatory power.
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Authors
Yuri Tserlukevich,