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Can the use of leverage adjustment techniques give reliable estimates of beta risk?

Dzhamalova, Valeriia LU (2010) NEKM02 20101
Department of Economics
Abstract
Title: Can the use of leverage adjustment techniques give reliable estimates of beta risk?

Purpose: Using the sample of American companies within the five industries for the period 1994-2009 the following hypothesis shall be tested: does the use of leverage adjustment techniques over-penalize the cost of equity for a high level of debt to equity ratio.

Methodology: To analyze how well the leverage adjustment works under the assumption of constant risk classes, the cross-sectional linear regression is used. With the purpose of relaxing the assumption of constant business risk within the industry to a constant business risk for a given firm, the time series methodology is employed.

Conclusions: In line with the previous studies it... (More)
Title: Can the use of leverage adjustment techniques give reliable estimates of beta risk?

Purpose: Using the sample of American companies within the five industries for the period 1994-2009 the following hypothesis shall be tested: does the use of leverage adjustment techniques over-penalize the cost of equity for a high level of debt to equity ratio.

Methodology: To analyze how well the leverage adjustment works under the assumption of constant risk classes, the cross-sectional linear regression is used. With the purpose of relaxing the assumption of constant business risk within the industry to a constant business risk for a given firm, the time series methodology is employed.

Conclusions: In line with the previous studies it is found that the leverage adjustment over-penalizes the beta risk for the high level of debt to equity ratio. The biggest difference between the theoretically implied betas and their empirical counterparts is observed for the cases with high leverage estimated by the model, which does not account for the tax savings from debt.Thus, one should be aware of the problems connected with the over-penalization of beta risk while dealing with the industries which a) include large number of the companies with different operational characteristics, and b) have a high level of debt to equity ratio. Therefore, I can suggest that it is possible to use leverage adjustment of beta, which accounts for tax savings by only averaging the unlevered beta for a small number of companies within homogeneous activities and low leverage level. (Less)
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author
Dzhamalova, Valeriia LU
supervisor
organization
course
NEKM02 20101
year
type
H2 - Master's Degree (Two Years)
subject
keywords
financial leverage, unlevered beta, Hamada’s leverage adjustment
language
English
id
1614688
date added to LUP
2010-06-11 14:17:52
date last changed
2010-06-11 14:17:52
@misc{1614688,
  abstract     = {Title: Can the use of leverage adjustment techniques give reliable estimates of beta risk?

Purpose: Using the sample of American companies within the five industries for the period 1994-2009 the following hypothesis shall be tested: does the use of leverage adjustment techniques over-penalize the cost of equity for a high level of debt to equity ratio.

Methodology: To analyze how well the leverage adjustment works under the assumption of constant risk classes, the cross-sectional linear regression is used. With the purpose of relaxing the assumption of constant business risk within the industry to a constant business risk for a given firm, the time series methodology is employed.

Conclusions: In line with the previous studies it is found that the leverage adjustment over-penalizes the beta risk for the high level of debt to equity ratio. The biggest difference between the theoretically implied betas and their empirical counterparts is observed for the cases with high leverage estimated by the model, which does not account for the tax savings from debt.Thus, one should be aware of the problems connected with the over-penalization of beta risk while dealing with the industries which a) include large number of the companies with different operational characteristics, and b) have a high level of debt to equity ratio. Therefore, I can suggest that it is possible to use leverage adjustment of beta, which accounts for tax savings by only averaging the unlevered beta for a small number of companies within homogeneous activities and low leverage level.},
  author       = {Dzhamalova, Valeriia},
  keyword      = {financial leverage,unlevered beta,Hamada’s leverage adjustment},
  language     = {eng},
  note         = {Student Paper},
  title        = {Can the use of leverage adjustment techniques give reliable estimates of beta risk?},
  year         = {2010},
}