Investigating the sources of Black’s leverage effect in oil and gas stocks

Abstract

The Black's leverage effect hypothesis postulates that a negative stock return innovation increases the financial leverage of a firm since the value of equity decreases at a given level of debt, which, in turn, creates a higher equity return volatility in the future. The paper is aimed at investigating the authenticity of the Black's leverage effect hypothesis and the relationship between negative stock returns and the financial leverage of the UK oil and gas stocks from 2004 to 2015. For each stock, exponential generalised autoregressive conditional heteroscedasticity model was estimated using Fama-French-Carhart 4-factor asset pricing model to extract the difference between the effects of negative and positive stock return innovations, regarded as leverage effect. The leverage effect parameter was further regressed on the financial leverage ratios of the book value of long-term debt to total assets, interest expenses to total assets and long-term debt to market value of equity to examine whether variation in the leverage parameter was as a result of variation in the firm's financial leverage. The findings of the study show that Fama-FrenchCarhart four risk factors of market, size effect, value and momentum were significant in the stock returns of most of the oil and gas companies. The mixed results in the significance level of the factors were attributed to the differences in individual firm characteristics. An evidence of leverage effect was also found in all the oil and gas stock returns but no evidence to suggest it was derived from the changes in the

Crude Oil Price Movements and Institutional Traders

“…We use these residuals in the transition probabilities of the model in Section 4 to test whether and how various traders contribute to the probability of low-volatility/bullish or high-volatility/bearish regimes in the crude oil market ( [43] labels the dichotomy of bullish/low-volatility and bearish/high-volatility regimes in markets as the "leverage effect." Recent papers examining this asymmetry in volatility include [44][45][46][47][48]). In this setting, fundamentals represent information while "unexplained" positions represent a measure of information processing [49,50] model the dual nature of information and information processing abilities among traders.…”