The Market Reaction to Interest Rate Change: The Effect of Financial Leverage

This research project examines the relationship between the financial leverage of firms with total book assets above $50M and the Target Federal Fund Rate changes during 1990 to 2015. We do not find that the value-weighted index is affected by change in interest rates. We find that increases in interest rate tends to hurt firms with higher book leverage (debt divided by total assets) than firms with low leverage. Unfortunately, these results do not seem to be robust, and we believe that the major reasons for that is that we use the full interest rate change, rather than the unanticipated component of interest rate change, which is unobservable.