Leverage Effects on the Swedish stock market

Abstract: The leverage effect is one of two main hypotheses explaining the negative relationship between volatility of returns and return on equity. It states that a decrease in leverage, due for example to rising stock prices, increases the amount of equity which carries the firm volatility and thus decreases the volatility on rates of return. Using 51 companies that have been actively traded on the Stockholm Stock Exchange for the 15 year period 1991-2005, this study examines the signs of a leverage effect on the Swedish market. Using returns, realized volatilities and debt levels the presence of the leverage effect, in competition with other models such as the volatility feedback effect, is examined. The study concludes that the effect on the Swedish market most likely is a combination of the leverage effect and some other effect, with the leverage effect being more predominant for small companies and less liquid assets. There are however some inconsistencies in the results, especially the lack of monthly observations of debt, which makes the conclusion open to speculation.