In this study, we investigate the impact of idiosyncratic and macroeconomic risks on the changes in leverage ratio, the components of changes in leverage ratio and the choice of debt-equity ratio of non-financial firms of Pakistan. We also included some firm-specific variables which are important in determining the leverage ratios of the firms. We exploit annual unbalance firm level data of non-financial firms obtained from the balance sheet analysis issued by state bank of Pakistan. The time period the data covers is 2000-2016. Our models contain the lag value of the dependent variable as a regressor, which creates the problem of endogeneity. To cure the problem of endogeneity and get accurate results, we applied Blundell-Bond (1998) system GMM. The results we obtained suggest that idiosyncratic and macroeconomic risks are inversely related to changes in both market and book leverage. The results of the models of the components of changes in leverage show that idiosyncratic risk has asymmetry influence across the components of change in leverage. We find that idiosyncratic risk is inversely correlated to debt finance, yet it increases firms’ reliance on equity finance and usage of internally generated funds. However, the coefficients of macroeconomic risk imply that macroeconomic risk has a negative effect on all three components of changes in leverage. Finally, we show that both macroeconomic and idiosyncratic risks have significant and inverse impact on the debt-equity ratio of the firms. Supervisor: Dr. Abdul Rashid Co-supervisor: Dr. Farhat Mahmood