Investing in a leveraged world
International Journal of Managerial Finance
ISSN: 1743-9132
Article publication date: 29 December 2023
Abstract
Purpose
Throughout the 21st century, US households have experienced unprecedented levels of leverage. This dynamic has been exacerbated by income shortfalls during the COVID-19 crisis. Leveraging and deleveraging decisions affect household consumption. This study investigates the effect of the dynamics of household leverage and consumption on the stock market.
Design/methodology/approach
The authors explore the relation between household leverage and consumption in the context of the consumption capital asset pricing model (CCAPM). The authors test the model's implication that leverage has a negative risk premium by transforming the asset pricing restriction into an unconditional linear factor model and estimate the model using the general method of moments procedure. The authors run time-series regressions to estimate individual stocks' exposures to leverage, and cross-sectional regressions to investigate the leverage risk premium.
Findings
The authors show that shocks to household debt have strong and lasting effects on consumption growth. The authors extend the CCAPM to accommodate this effect and find, using various test assets, a negative risk premium associated with household deleveraging. Looking at individual stocks the authors show that the deleveraging risk premium is not explained by well-known risk factors.
Originality/value
This paper contributes to the literature on the role of leverage in economics and finance by establishing a relation between household leverage and spending decisions. The authors provide novel evidence that households' leveraging and deleveraging decisions can be a fundamental and influential force in determining asset prices. Further, this paper argues that household leverage might explain the small, persistent, and predictable component in consumption growth hypothesised in the long-run risk asset pricing literature.
Keywords
Acknowledgements
The authors thank Tālis Putniņš and seminar participants at the University of Technology Sydney for their useful and insightful comments. The comments from an anonymous referee are also gratefully acknowledged. All errors remain our own. This research did not receive any specific grant from funding agencies in the public, commercial, or not-for-profit sectors.
Citation
Ahn, K., Hambusch, G., Hong, K. and Navone, M. (2023), "Investing in a leveraged world", International Journal of Managerial Finance, Vol. ahead-of-print No. ahead-of-print. https://doi.org/10.1108/IJMF-12-2022-0538
Publisher
:Emerald Publishing Limited
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