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San Diego State University

Fowler College of
Business Administration

Intellectual Contribution

Title
Variance Risk Premia and Capital Structure
Author(s)
Lotfaliei, B.
Type of Research
Others
Date Published
2014, Before July
Contribution Type
Publisher
Working paper
URL
http://www.babakl.com/research/variance-risk-premia-and-capital-structure
Abstract
This paper shows that the optimal leverage decreases with asset volatility risk in a trade-off framework. Thus, the paper relates the asset volatility risk premium to the underleverage puzzle. In models without volatility risk, the paper empirically documents that underleverage increases with the assets' volatility risk premium. In particular, the underleverage is most important for investment-grade firms with low historical volatility and high volatility risk premium. With volatility risk, two models in standard trade-off settings show that a higher premium implies lower leverage. Empirically, the models' calibration leaves no significant underleverage patterns in the cross-section of the firms. Hence, high asset volatility risk premia contributes to the apparent underleverage in the firms with relatively low historical asset volatility.