Is Unlevered Firm Volatility Asymmetric?

We develop a new, unlevering approach to document how well financial and operating leverage explain volatility asymmetry on a firm-by-firm basis. Volatility asymmetry means that when stock price drops (rises), the volatility of the returns typically increases (decreases). Our evidence, using a large sample of U.S. firms, shows that almost all of the firm-level asymmetry can be explained by financial leverage and, to a smaller extent, operating leverage. This result is robust even when we allow for risky debt. On the index-level, however, even after removing financial and operating leverage from each component firm, a large portion of volatility asymmetry persists. When the market goes down, unlevered index-level returns have higher volatility because the unlevered component stock returns have higher covariance rather than higher volatility. Covariance asymmetry explains why financial leverage causes the firm-level asymmetry but not the index-level asymmetry