Dissertations, Theses, and Capstone Projects

Date of Degree


Document Type


Degree Name





Liuren Wu

Committee Members

Lin Peng

Armen Hovakimian

Ren-Raw Chen

Subject Categories

Finance and Financial Management


Capital structure, optimal risk taking, optimal leverage target, optionality, risk aversion, structural model


Chapter 1 This paper treats a firm’s capital structure decision as an optimal risk-taking decision based on its risk-return tradeoff prospect. The paper proposes to construct mean-variance ratio forecasts based on return-on-asset histories and shows that the forecasts can explain a large proportion of the cross-sectional company leverage variation. The leverage predicted by the mean-variance ratio forecast maximizes a firm’s relative value. Once the mean-variance ratio forecast is accounted for, contributions from other commonly identified variables become small. Furthermore, some of the additional explained variations do not constitute value-maximizing leverage target variations, but rather variations away from the target.

Chapter 2 Investors are averse to risk, but love optionality. When a security’s embedded optionality increases with its risk level, the entanglement, combined with the opposite investor preferences, can generate seemingly abnormal market pricing behaviors. This paper frames the bond and stock return behavior within a structural framework and disentangles their directional risk exposure from their optionality exposure via a joint stock-bond return factor model. The factor portfolio targeting a unit exposure to market risk but zero exposure to optionality generates a significantly positive average excess return, consistent with investor risk aversion. By contrast, the factor portfolio targeting a unit exposure to optionality but without directional exposure to firm value variation generates a significantly negative average excess return, reflecting investor penchant for optionality. The separation of risk from optionality sheds light on the distress puzzle in the stock and bond market and helps explain the bet-against-beta and volatility premiums in the stock market.

This work is embargoed and will be available for download on Monday, June 02, 2025

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