We use forward-looking and exogenous measures of output price uncertainty to examine the effect of price uncertainty on firm-level capital investment, risk management, and debt issuance. The effects of uncertainty vary significantly by firm size. When faced with high price uncertainty, large firms increase their hedging intensity but do not lower capital investment or debt issuance. In contrast, small firms do not adjust their hedging intensity but significantly lower capital expenditure and debt issuance even after controlling for investment demand. Moreover, the negative effect of uncertainty on capital investment is significantly weaker for firms that hedge their output price risk. Our analysis highlights that, in the presence of financial frictions, high price uncertainty has significant dampening effects on capital investment of small firms by exacerbating their financial constraints, and that this negative effect is amplified by firm-level constraints on ability to hedge risk exposures.
Building on theoretical asset pricing literature, we examine the role of market risk and the size, book‐to‐market (BTM), and volatility anomalies in the cross‐section of unlevered equity returns. Compared with levered (stock) returns, unlevered market beta plays a more important role in explaining the cross‐section of unlevered equity returns, even after controlling for size and BTM. The size effect is weakened, while the value premium and the volatility puzzle virtually disappear for unlevered returns. We show that leverage induces heteroskedasticity in returns. Unlevering returns removes this pattern, which is otherwise difficult to address by controlling for leverage in regressions.
We specify and estimate no-arbitrage models for sovereign CDS contracts by assuming that the country's default intensity depends on observable economic and …nancial indicators. We estimate these models using a sample of twenty-eight countries, three CDS maturities, and over a decade of daily data. The models provide a good …t. The impact of the economic and …nancial variables on spreads is consistent with economic intuition. Spreads increase as a function of stock market and exchange rate volatility, but decrease as a function of interest rates and stock market returns. The magnitudes of these impacts vary substantially across countries and over time. Estimated risk premiums are also highly time-varying and peak during the 2008 …nancial crisis for nearly all countries. For European countries, the risk premiums are also high during the Eurozone debt crisis. In periods of market stress and high CDS spreads, the increase in market risk premiums is even larger than the increase in default probabilities. The cross-sectional variation in risk premiums across countries is high, also in non-crisis periods.
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