On the causality analysis of the correlation between financial leverage and systematic risk: evidence from Indonesian Stock Exchange

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This research is aimed at analyzing the causality puzzle on the correlation between financial leverage and systematic risk (beta). Financial leverage and beta are usually considered as two proxies of risk derived from different domains: one ends at financial decision outcome, and the other points to market. Cross-sectionally, this result does not support the moderating-variable impact of size on the relation between financial leverage and systematic risk. On the other hand, however, the moderating-variable impact of industry and operating leverage (to some extent) on the relation between financial leverage and systematic risk were well documented. Inter-temporally, financial leverage is significantly and symmetrically related to beta, not moderated by size and operating leverage. This means that the two variables show bidirectional causality. This study contributes to the new insight that financial leverage and beta are the two variables with bidirectional causality, showing that in the long run, risks from fundamental (financial/micro-economy) and from market (macro-economy) are tightly linked to each other inter-temporally.

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    • Figure 1. The conceptual framework for Hypothesis 1, 2, and 3
    • Figure 2. The conceptual framework for Hypothesis 4
    • Table 1a. Descriptive statistics for cross-sectional data (average period 2012–2013)
    • Tabel 1b. Descriptive statistics for temporal data (2006–2014)
    • Table 2. Regression results of the relation between financial leverage and beta (panel A moderated by size; panel B moderated by operating leverage; and panel C moderated by industry)
    • Table 3. The regression results of the relation between financial leverage and beta (moderated by size, operating leverage, and industry)
    • Table 4. DF and ADF test
    • Table 5. The estimation results for model 5, 6, 7, and 8 (beta is adjusted)2