The Impact of Size and Leverage on Equity Volatility

Many valuation practitioners rely on equity volatilities when performing equity allocations, derivative valuations, discounts for lack of marketability, or contingent consideration analyses. Yet in contrast to other commonly accepted valuation adjustments,¹ practitioners still appear hesitant to adjust historical or implied volatilities from publicly traded comparables for differences in size when performing these types of analyses, despite theory that these factors should impact equity volatility.² Instead, preference is usually made in the industry to adjust equity volatilities for leverage alone.

In this paper I provide analytical support across a twenty-year time horizon using a five-year lookback period to examine the empirical impact of size and leverage on equity volatilities.

I find that size has substantial impact on equity volatilities and provide suggested volatility size adjustments for equity volatility. Further, I find evidence that while leverage does have an impact on equity volatilities, the impact is less than what the Merton model would imply. I find interesting evidence that equity volatilities may behave counter to the Merton model with or without adjusting for size.