Endogenous leverage and expected stock returns

T. C. Johnson, T. Chebonenko, I. Cunha, F. D'Almeida, X. Spencer

Research output: Contribution to journalArticlepeer-review

12 Scopus citations


This note clarifies conditions under which endogenous choice of debt induces a negative relation between leverage or default risk and expected stock returns. In the context of the model of George and Hwang [2009. Journal of Financial Economics 96, 56-79], we correct the contention that variation in bankruptcy costs across firms is sufficient. Variation in asset risk parameters can lead to the desired relation, but may not when also controlling for variation in book-to-market ratios. A simple parameterization of cross-sectional heterogeneity in risk and profitability implies a negative association of expected return with leverage and distress risk and a positive association with book-to-market.

Original languageEnglish
Pages (from-to)132-145
Number of pages14
JournalFinance Research Letters
Issue number3
StatePublished - Sep 2011


  • Expected stock returns
  • Optimal capital structure

ASJC Scopus subject areas

  • Finance


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