A Note on the Dynamics of Target Leverage Ratios

C Lo, C Hui
In this communication we have proposed a simple model for the dynamics of the target leverage ratio of a rm and performed a theoretical investigation of its time path. The gap between a rm's current target leverage ratio and the long-term target ratio is found to diminish exponentially, and the decay rate is determined by the volatility of the leverage ratio and the long-term target ratio only. The time-varying target leverage ratios can be readily incorporated into the dynamics of the leverage
more » ... ics of the leverage ratios of individual rms, and the default probabilities of individual rms can be generated to assess the default risks of the rms.