Capital structure volatility, financial vulnerability, and stock returns: Evidence from Korean firms

Using a large dataset of listed firms in Korea, we test whether volatility of capital structure affects stock returns in a systematic way. Stock returns of high capital-structure-volatility firms belonging to different size groups move together over time, suggesting the existence of a capital structure-volatility factor. This factor earns a sizable, negative risk-premium of 1.08% on a monthly basis over the sample period spanning 2004-2017, and the factor return is adversely affected by deteriorating financial market conditions. Moreover, the cross-sectional relation between capital structure volatility and stock returns is also negative. Overall results indicate that the capital structure volatility may represent another pricing puzzle in stock markets.