Leverage as a risk factor in explaining the cross section of stock returns: evidence from the Johannesburg Securities Exchange (JSE)

Abstract

This study investigated whether there is a leverage risk premium that helps explain the crosssectional variation in stock return for Johannesburg Securities Exchange (JSE) listed companies. The explanatory power of the Capital Asset Pricing Model (CAPM), the Fama and French threefactor (FF3F) model and the leverage augmented FF3F model were compared. The results suggest that the beta, size, value and leverage premia are all relevant factors in explaining stock returns in South Africa. Further, the results suggest that the leverage augmented FF3F model performs better than the classic FF3F model and CAPM in explaining the cross-sectional variation in average stock returns. Thus, the evidence in this study indicates that leverage is a priced risk factor.