Stock comovement and financial flexibility
Keywords: 
Return Comovement
Financial Flexibility
COVID-19
Issue Date: 
24-Nov-2022
Publisher: 
Cambridge University Press
ISSN: 
1756-6916
Note: 
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence
Citation: 
Huang, T., Kumar, A., Sacchetto, S., & Vergara-Alert, C. (2022). Stock Comovement and Financial Flexibility. Journal of Financial and Quantitative Analysis, 1-44. doi:10.1017/S0022109022001338
Abstract
We develop a dynamic model of corporate investment and financing, in which shocks to the value of collateralizable assets generate variation in firms’ debt capacity. We show that the degree of similarity among firms’ financial flexibility forecasts cross-sectional variation in return correlation. We test the implications of the model with firm-level data in two empirical analyses using i) an instrumental variable approach based on shocks to the value of collateralizable corporate assets and ii) the outbreak of the COVID-19 crisis as an event study. We find that firms in the same percentile of the cross-sectional distribution of financial flexibility have 62% higher correlation in stock-return residuals than firms 50 percentiles apart.
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