Volatility of Corporate Debt Financing and Cross-Section of Stock Returns : Empirical Analysis of Financial Constraint Puzzle in Korea

Abstract

This paper investigates the effects of the volatility of debt financing on cross-sectional variation of stock returns. Through the empirical analysis of listed firms in Korea for the 2005-2016 estimation period, this paper provides persistent and significant evidence that the volatility of debt financing has negative impacts on stock returns while controlling for market factor and firm characteristics such as size factor (firm size, market capitalization), value factor (book-to-market ratio), and momentum factor. While using both monthly average of stock returns and Fama-French-Carhart 4-factor risk-adjusted stock returns as dependent variables, the estimations of Fama-MacBeth cross-sectional regressions produce negative and statistically significant coefficient on the volatility of debt financing. The findings of this paper makes an academic contribution by providing the evidence that the volatility of debt financing, as a measure of financial constraint, plays a role as an anomaly factor for “financial constraint pricing puzzle” in Korean stock market.

Citation

Kim, H., Chong, B.-U. and Hwang, I.-D. (2017), "Volatility of Corporate Debt Financing and Cross-Section of Stock Returns : Empirical Analysis of Financial Constraint Puzzle in Korea", Journal of Derivatives and Quantitative Studies: 선물연구, Vol. 25 No. 1, pp. 97-138. https://doi.org/10.1108/JDQS-01-2017-B0004