Performance of a Trading Strategy Based on Changes in Capital Structure

Abstract

Capital structure is a widely discussed topic in the financial literature. Previous research is mixed regarding changes in capital structure and its impact on return on equities. It is well documented in the literature that investors should invest in well-diversified index funds as they give the best risk-adjusted return. More recent studies shows that investors can increase their risk-adjusted return from active strategies where the investors concentrate their portfolio by analysis of companies and the market, see for example Fjesme (2019, 2020). In this article we examine whether a trading strategy that buys companies that reduce the debt ratio and short sells companies that increase the debt ratio can beat the market at Oslo Stock Exchange. This is done by constructing portfolios based on data for all companies listed on the Oslo Stock Exchange from January 2002 until November 2020. We document that it is possible to beat the market by following the strategy when adjusting for risk and the strategy generates up to 11.61% annual risk-adjusted excess return.