Can leverage effect coexist with value effect?

Abstract

In this paper, we evaluate the cross sectional relationship between firm characteristics, financial leverage, and stock returns for the Indian stock market. The study finds that there are strong size and value effects existing in the return pattern of stocks, and also finds a complex pattern between leverage and stock returns in the Indian context. The Gibbons, Ross, and Shanken (GRS) test confirms the robustness of three factor model with market, size, and leverage over Fama-French three factor model (1993) in most cases. The Wald test confirms that the effects of value and leverage are the same in determining portfolio returns in most cases. Further, study estimates show that portfolios formed using value and leverage breakpoints are not much sensitive to the results unlike portfolios formed using size breakpoints.