EXPLORING THE ASSOCIATION BETWEEN FINANCIAL DEREGULATION AND LEVERAGE EFFECT IN AN EMERGING MARKET
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Abstract
This paper investigates the association between financial deregulation and the leverage effect in the Pakistan Stock Exchange (PSX). The study aims to explore the relationship between volatility change and stock returns before and after deregulation. The data set in this study covers the period from 2003 to 2016. The hypothesis established in this study is that the leverage effect after financial deregulation is positive and less significant compared to the period without deregulation. The return-risk theoretical relationship is estimated through the model of the return volatility caused by the leverage (Cheung and Ng, 1992; Schwert, 1989; French, et al., 1987; and Christie, 1982). The results show that industry-level leverage has historically seemed high. Therefore, the relationship of stock return to volatility change is consistently significant and negative, thereby, explaining the leverage effect better during the period of non-reforms/regulation. Balancing deregulation with adequate regulatory control and promoting stronger corporate governance is crucial for ensuring the stability and long-term sustainability of the corporate sector.
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