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dc.contributor.authorHess, Dieteren_US
dc.contributor.authorImmenkötter, Philippen_US
dc.description.abstractWe study the effect of the business cycle on optimal capital structure choice and the benefit to leverage. We propose a regime switching model with a state-dependent cash flow process to capture macroeconomic risk in a firm's cash flow. Our model is parsimonious but still realistic and allows for a wide range of analysis. We find pro-cyclical optimal leverage ratios, benefits to leverage, and costs of operating at a non-optimal leverage. If macroeconomic risk decreases, i.e. earnings become more stable and growth rates less volatile, optimal leverage and its benefits increase due to lower default risk. The regime switching property of EBIT traces observed EBIT paths closely and is applicable to a wide range of corporate valuation models. Our model offers novel empirically testable implications, such as higher tax benefits after the change in macroeconomic risk since the late 1980s and common capital structure adjustments in recessions and around turning points.en_US
dc.publisher|aCentre for Financial Research |cCologneen_US
dc.relation.ispartofseries|aCFR working paper |x11-12en_US
dc.subject.keywordcapital structureen_US
dc.subject.keywordmacroeconomic risken_US
dc.subject.keywordregime switchingen_US
dc.subject.keywordbenefit to leverageen_US
dc.titleOptimal leverage, its benefits, and the business cycleen_US
dc.typeWorking Paperen_US

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