How will stock return be measure to capture volatility leverage effect?
An easy way of testing it would be employing a Threshold GARCH approach.
1. First, ensure the data is stationary; get the log returns.
2. Estimate an ordinary regression to visually check for volatility clustering and/or check for ARCH effect.
3. If affirmative, proceed to TARCH.
4. Should the coefficient in the variance equation be positive and significant, you got yourself Leverage Effect.
5. Lastly, kick the tires. Check for normality and ARCH of residuals as well as autocorrelation.
Voila!
Good luck.
Dear Olugbode
If the P/E ratio (price-to-earnings) is constant, with a negligible dividend payout ratio, then the relation (using book values) between financial leverage and equity return can be simply measured by the degree of financial leverage (DFL). The DFL equals (EBIT)/(EBIT - F) where EBIT is the earnings before interest and taxes and F is the fixed financial costs.
Pretty significant literature exist on this.
U may look at a similar one
.
http://lup.lub.lu.se/luur/download?func=downloadFile&recordOId=1667687&fileOId=1667688
Measurement of leverage effects with respect to Risk premium in relation to investment premium.
Thank you Daniel. The link is quite reached and of great help. It considered risk premium and used GARCH process. Looking forward to Standard GARCH process and incorporating investment premium feedback. Once again thank you for your assistant.
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