Stock Comovement and Financial Flexibility

Teng Huang, Anil Kumar, Stefano Sacchetto, Carles Vergara-Alert

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Abstract

We develop a dynamic model of corporate investment and financing, in which shocks to the value of collateralizable assets generate variation in firms' debt capacity. We show that the degree of similarity among firms' financial flexibility forecasts cross-sectional variation in return correlation. We test the implications of the model with firm-level data in two empirical analyses using i) an instrumental variable approach based on shocks to the value of collateralizable corporate assets and ii) the outbreak of the COVID-19 crisis as an event study. We find that firms in the same percentile of the cross-sectional distribution of financial flexibility have 62% higher correlation in stock-return residuals than firms 50 percentiles apart.

Original languageEnglish
JournalJournal of Financial and Quantitative Analysis
Volume59
Issue3
Pages (from-to)1141-1184
Number of pages44
ISSN0022-1090
DOIs
Publication statusPublished - May 2024

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