Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/73471
Authors: 
Qiu, Jianying
Mahagaonkar, Prashanth
Year of Publication: 
2009
Series/Report no.: 
Working Papers in Economics and Statistics 2009-12
Abstract: 
In this paper, we directly test the Modigliani-Miller theorem in the lab. Applying a general equilibrium approach and not allowing for arbitrage among firms with different capital structures, we are able to address this issue without making any assumptions about individuals' risk attitudes and initial wealth positions. We find that, consistent with the Modigliani-Miller theorem, experimental subjects well recognized the increased systematic risk of equity with increasing leverage and accordingly demanded higher rate of return. Furthermore, the correlation between the value of the debt and equity is -0.94, which is surprisingly comparable with the -1 predicted by the Modigliani-Miller theorem. Yet, a U shape cost of capital seems to organize the data better.
Subjects: 
The Modigliani-Miller Theorem
Experimental Study
Decision Making under Uncertainty
General Equilibrium
JEL: 
G32
C91
G12
D53
Document Type: 
Working Paper

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