Stock returns, oil prices and leverage: evidence from US firms

Purpose - This paper aims to investigate how the relation between stock returns of US firms and West Texas Intermediate (WTI) oil prices is affected by leverage from 1990 to 2020. Design/methodology/approach - This paper examines how the relationship between stock returns of US firms and WTI oil prices is affected by leverage from 1990 to 2020 using a fixed-effect model estimation framework. Findings - Results from the fixed-effect regression models suggest that leverage effects on stock returns are pervasive both in aggregate and cross-industry levels, while the mining industry is more sensitive. In addition to the positive oil price effects attenuated by leverage at the aggregate level, the authors observe stronger marginal effects of leverage only for the mining sector. Being more exposed to commodity prices, the positive effects of oil prices on stock returns in the mining sector are offset by large debt ratios. Asymmetries, effects of debt maturity structure and implications are also discussed. Research limitations/implications - This study is grounded on the contemporary cash flow claim of leverage NOT on the long-run effect of leverage considering cash flow constraints. The oil price increase is assumed to represent an advancement of the overall economy. This study does not capture the oil prices response to some other economic forces and vice-versa. Practical implications - Mining companies should therefore reduce the stock of debt with respect to their assets to make possible the “pass-through” from oil prices to the stock market. Originality/value - Previously undocumented and the authors show that leverage reduces the total effect of oil prices on stock returns, consistent with the hypothesis. Asymmetric and debt maturity structures effects are also discussed.