Three Factor Leverage Models: Theory and Evidence in Taiwan

[[abstract]]This paper proposes a three factor leverage model: “(1 & 2) the mean and standard deviation of leverage contribution and (3) the pecking order”, and extends the debt in the pecking order to “Non-Leverage Debt (NLD) first, then leverage debt.” After decrypting financial risk, this paper provides (1) the logic, models, and methodology of the leverage contribution models which integrate “mean-variance framework and the pecking order”, and (2) excellent evidence in Taiwan. Business risk is an autonomous risk, and is the engine of risk. Financing is the transmission of business risk. Just as earthquakes have two dimensions—intensity and depth—so with financial risk. In empirical work, our models cannot be applied to huge leverage loss, because leverage contribution assumes that leverage is profitable