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Abstract:
We study the risk of value and growth stocks. We find that time-varying risk goes in the right direction in explaining the value premium. Value betas tend to covary positively, and growth betas tend to covary negatively with the expected market risk premium. Our inference differs from that of previous studies because we sort conditional betas on the expected market risk premium, instead of on the realized market excess return. However, we also find that this beta-premium covariance is too small to explain the observed magnitude of the value premium within the conditional CAPM.

Abstract:
Yes! We study the time-varying risk patterns of value and growth stocks across business cycles. We find that the conditional market betas of value stocks covary positively with the expected market risk premium, and that value stocks are riskier than growth stocks in bad times when the expected market risk premium is high. The opposite is true for growth stocks. Methodologically, we measure time-varying risk by sorting conditional betas on the theoretically justified expected market risk premium, instead of the ex post realized market excess return. Our findings lend support to the predictions of recent rational asset pricing theory.

Value, Growth, Asymmetric Beta, Expected Risk Premium, Business Cycles

Abstract:
A new three-factor model consisting of the market factor and common factors formed on investment and return on assets goes a long way in summarizing the cross-sectional variation of expected stock returns. The model substantially outperforms traditional asset pricing models in describing average returns across testing portfolios formed on short-term prior returns, financial distress, net stock issues, asset growth, and earnings surprises. The model also performs roughly as well as the Fama-French model in accounting for average returns across portfolios formed on valuation ratios, industry, and CAPM betas. The model's performance, combined with its economic intuition, suggests that it can be used to obtain expected return estimates in practice.

Anomalies, alpha, q-theory, factor regression, investment-based asset pricing

Abstract:
We take a simple q-theory model and ask how well it can explain external financing anomalies, both qualitatively and quantitatively. Our central insight is that optimal investment is an important driving force of these anomalies. The model simultaneously reproduces procyclical equity issuance waves, the negative relation between investment and average returns, long-term underperformance following equity issues, positive long-term drift following cash distributions, the mean-reverting operating performance of issuing and cash-distributing firms, and the failure of the CAPM in explaining the long-term stock-price drifts. However, the model cannot fully capture the magnitude of the positive drift following cash distributions observed in the data.

Anomalies, the q-theory, optimal investment, time-varying expected return, rational expectations economics

Abstract:
I construct a neoclassical, Q-theoretical foundation for time-varying expected returns in connection with corporate policies and events. Under certain conditions, stock return equals investment return, which is directly tied with firm characteristics. This single equation is shown analytically to be qualitatively consistent with many anomalies, including the relations of future stock returns with market-to-book, investment and disinvestment rates, seasoned equity offerings, tender offers and stock repurchases, dividend omissions and initiations, expected profitability, profitability, and more important, earnings announcement. The Q-framework also provides a new asset pricing test.

Abstract:
The q-theory implies that investment is a first-order determinant of the cross section of expected returns, and that optimal investment drives the external financing anomalies. Our neoclassical model simultaneously and in many cases quantitatively reproduces: Procyclical equity issuance waves; stock market predictability with the new equity share; the negative relation between investment and average returns; long-term underperformance following equity issuance; the mean-reverting operating performance of issuing and cash-distributing firms; and the positive long-term drift following cash distribution and its positive relation with book-to-market. Our model also generates the failures of the CAPM in capturing these anomalies.

Anomalies, Tobin's Q, time-varying expected return, rational expectations, behavioral finance

Abstract:
Earnings management is a corporate decision subject to costs. Both earnings management in the IPO process and the ex ante delisting risk of newly issued firms are related to firm fundamentals. With a sample of IPOs from 1980 to 1999, we find that the degree of earnings management possesses significant predictive power on IPO failure. IPO firms associated with aggressive earnings management are more likely to delist for performance failure, and tend to delist sooner. Furthermore, we find that IPO firms associated with conservative earnings management are more likely to be merged or acquired and they earn positive abnormal returns. Our results also show that IPO issuers manage earnings in response to market demand. Market-wide earnings management of IPO firms interacts with the IPO cycle documented by Lowry and Schwert (2002).

Earnings management, delisting rate, life expectancy, IPOs

Abstract:
We use yield spreads to construct ex-ante returns on corporate securities, and then use the ex-ante returns in asset pricing assets. Differently from the standard approach, our tests do not use ex-post average returns as a proxy for expected returns. We find that the market beta plays a much more important role in the cross-section of expected returns than previously reported. The expected value premium is significantly positive and countercyclical. We find no evidence of ex-ante positive momentum profits.

Abstract:
We use corporate bond yield spreads to gauge investors' return expectations. We then replace standard ex-post, averaged measures of return with our ex-ante return measures in asset pricing assets. We find that the market beta plays a significant role in the cross-section of returns when expectations are measured ex-ante. The expected size and value premia are significantly positive and countercyclical, but there is no evidence of ex-ante positive momentum profits.

Expected Returns, Risk Factors, Systematic Risk, Yield Spreads

Abstract:
We conduct a comprehensive study of the cyclical movements in economic fundamentals for value and growth firms. We document that the fundamentals of value firms are more adversely affected by negative business cycle shocks than those of growth firms. The differential response between value and growth firms is mostly significant. We also present some evidence suggesting that lack of flexibility in capital investment underlies the more cyclical behavior of value firms.

Value, growth, economic fundamentals, business cycles, VAR

Abstract:
The value anomaly arises naturally within the neoclassic, rational expectations framework with competitive equilibrium. Costly reversibility and countercyclical price of risk cause assets in place to be much harder to adjust downward, and hence riskier, than growth options, especially in bad times when the price of risk is high. By linking risk and expected return to economic primitives, such as tastes and technology, the model generates many empirical regularities in the cross-section of returns; it also yields a rich array of new refutable hypotheses that can provide fresh directions for future empirical research.

The Value Premium, Corporate Investment, Assets-in-Place, Growth Option, Costly Reversibility, Rational Expectations Economics

Abstract:
I investigate the economic determinants of risk and expected return within a neoclassic framework of industry equilibrium augmented with capital investment and aggregate uncertainty. Due to asymmetry in capital adjustment cost, assets-in-place is much riskier than growth option in bad times and growth option is riskier than assets-in-place only in good times and to a lesser extent. Coupled with a time-varying price of risk, this mechanism goes a long way in explaining the value premium puzzle, the coexistence of a high return dispersion and a low unconditional beta dispersion between value and growth stocks. The model also yields an array of new testable predictions both in the time series and cross-section.

The Value Premium, Industry Equilibrium, Optimal Investment, Assets-in-Place, Growth Option, Asymmetric Adjustment Cost

Abstract:
Fama and French (2002) estimate the equity premium using dividend growth rates to measure expected rates of capital gain. We apply their method to study the value premium. From 1945 to 2005, the expected value premium is on average 6.1% per annum, consisting of an expected dividend-growth component of 4.4% and an expected dividend-price-ratio component of 1.7%. Unlike the equity premium, the value premium has been largely stable in the last half century.

The Value Strategy, Expected Returns, Dividend Growth, Dividend Price Ratio, Capital Gains

Abstract:
Fama and French (2002) estimate the equity premium using dividend growth rates to measure the expected rate of capital gain. We use similar methods to study the value premium. From 1941 to 2002, the expected HML return is on average 5.1% per annum, consisting of an expected-dividend-growth component of 3.5% and an expected-dividend-to-price component of 1.6%. The ex-ante HML return is also countercyclical: a positive, one-standard-deviation shock to real consumption growth rate lowers this premium by about 0.45%. Unlike the equity premium, there is only mixed evidence suggesting that the value premium has declined over time.

Abstract:
Fama and French (2002) estimate the equity premium using dividend growth rates to measure expected rates of capital gain. We use a similar method to study the value premium. From 1941 to 2005, the expected HML return is on average 6.0% per annum, consisting of an expected dividend-growth component of 4.4% and an expected dividend-price-ratio component of 1.6%. The expected HML return is also countercyclical: a positive, one-standard-deviation shock to real consumption growth lowers this premium by about 0.40%. Unlike the equity premium, there is only mixed evidence suggesting that the expected value premium has declined over time.

The Value Premium, Expected Returns, Dividend Growth, Dividend Price Ratio

Abstract:
We explicitly link expected stock returns to firm characteristics such as firm size and book-to-market ratio in a dynamic general equilibrium production economy. Despite the fact that stock returns in the model are characterized by an intertemporal CAPM with the market portfolio as the only factor, size and book-to-market play separate roles in describing the cross-section of returns. These firm characteristics appear to predict stock returns because they are correlated with the true conditional market beta of returns. These cross-sectional relations can subsist after one controls for a typical empirical estimate of market beta. This lends support to the view that the documented ability of size and book-to-market to explain the cross-section of stock returns is not necessarily inconsistent with a single-factor conditional CAPM model.

Production based asset pricing, beta, size and book-to-market factors, CAPM, business cycle properties of stock returns

Abstract:
We explicitly link expected stock returns to firm characteristics such as firm size and book-to-market ratio in a dynamic general equilibrium production economy. Despite the fact that stock returns in the model are characterized by an intertemporal CAPM with the market portfolio as the only factor, size and book-to-market play separate roles in describing the cross-section of returns. These firm characteristics appear to predict stock returns because they are correlated with the true conditional market beta of returns. These cross-sectional relations can subsist after one controls for a typical empirical estimate of market beta. This lends support to the view that the documented ability of size and book-to-market to explain the cross-section of stock returns is not necessarily inconsistent with a single-factor conditional CAPM model. Our model also gives rise to a number of additional implications for the cross-section of returns. In this paper, we focus on the business cycle properties of returns and firm characteristics. Our results appear consistent with the limited existing evidence and provide a benchmark for future empirical studies.
cycle properties

General equilibrium, the cross-section of returns, beta, size, book-to-market ratio, firm heterogeneity, business

Abstract:
We propose a new multifactor model that consists of the market factor and factor mimicking portfolios based on investment and productivity motivated from neoclassical reasoning. The neoclassical three-factor model goes a long way in explaining the average returns across testing portfolios formed on momentum, financial distress, investment, profitability, net stock issues, and valuation ratios. In particular, winners have higher loadings than losers on both the low-minus-high investment factor and the high-minus-low productivity factor. We suggest that the neoclassical model is a good start to understanding the cross-sectional variations of average stock returns.

The cross-section of returns, anomalies, neoclassical economics, factor regressions

Abstract:
Interpreting accruals as working capital investment, we hypothesize that firms rationally adjust their investment to respond to discount rate changes. Consistent with the optimal investment hypothesis, we document that (i) the predictive power of accruals for future stock returns increases with the covariations of accruals with past and current stock returns, and (ii) adding investment- based factors into standard factor regressions substantially reduces the magnitude of the accrual anomaly. High accrual firms also have similar corporate governance and entrenchment indexes as low accrual firms. This evidence suggests that the accrual anomaly is more likely to be driven by optimal investment than by investor overreaction to excessive growth or over-investment.

Abstract:
Interpreting accruals as working capital investment, we hypothesize that firms rationally adjust their capital investment to respond to discount rate changes. Consistent with the discount-rate hypothesis, we document that (i) the predictive power of accruals for future returns increases with the correlations of accruals with past and current stock returns;(ii) controlling for investment substantially reduces the magnitude of the accrual anomaly; (iii) the ex-ante expected returns of various accrual strategies have been stable at around 5% per annum over the past 35 years; (iv) the accounting reliability of various accrual components is inversely related to their cross-correlations with investment-to-assets; and finally (v) high accrual firms have similar corporate governance and entrenchment indexes as low accrual firms, suggesting that the accrual anomaly is unlikely to be driven by investor overreaction to over-investment.

The accruals anomaly, total accruals, discretionary accruals, net operating assets, investment-based asset pricing, capital investment, time-varying expected returns

Abstract:
We use a production-based asset pricing model to investigate whether financial market imperfections are quantitatively important for pricing the cross-section of returns. Specifically, we use GMM to explore the stochastic Euler equation restrictions imposed on asset returns by optimal investment behavior. Our methods allow us to identify the impact of financial frictions on the stochastic discount factor with cyclical variations in cost of external funds. We find that financing frictions provide a common factor that can improve the pricing of the cross section of stock returns. In addition, we find that the shadow cost of external funds exhibits strong procyclical variation so that financial frictions are more important when economic conditions are relatively good.

Financing constraints, production-based asset pricing, structural estimation, cyclicality, the cross-section of returns

Abstract:
We incorporate costly external finance in an investment-based asset pricing model and investigate whether financing frictions are quantitatively important for pricing a cross-section of expected returns. We show that common assumptions about the nature of the financing frictions are captured by a simple 'financing cost' function, equal to the product of the financing premium and the amount of external finance. This approach provides a tractable framework for empirical analysis. Using GMM, we estimate a pricing kernel that incorporates the effects of financing constraints on investment behavior. The key ingredients in this pricing kernel depend not only on 'fundamentals', such as profits and investment, but also on the financing variables, such as default premium and the amount of external financing. Our findings, however, suggest that the role played by financing frictions is fairly negligible, unless the premium on external funds is procyclical, a property not evident in the data and not satisfied by most models of costly external finance.

Abstract:
We incorporate costly external finance in a production based asset pricing model and investigate whether financing frictions are quantitatively important for pricing a cross-section of expected returns. We show that the common assumptions about the nature of the financing frictions are captured by a simple 'financing cost' function, equal to the product of the financing premium and the amount of external finance. This approach provides a tractable framework to examine the role of financing frictions in pricing a cross-section of asset returns. Using the Generalized Method of Moments (GMM) we estimate a pricing kernel that incorporates the effects of financing constraints on investment behavior. The key ingredients in this pricing kernel depend not only on 'fundamentals', such as profits and investment, but also on the financing variables. Our findings, however, suggest that the role played by financing frictions is fairly negligible, unless the premium on external funds is procyclical, a property not evident in the data and not satisfied by most models of costly external finance.

Production based asset pricing, financing constraints, financing premium

Abstract:
We incorporate costly external finance in an investment-based asset pricing model and investigate whether financing frictions are quantitatively important for pricing a cross-section of expected returns. We show that common assumptions about the nature of the financing frictions are captured by a simple "financing cost" function, equal to the product of the financing premium and the amount of external finance. This approach provides a tractable framework for empirical analysis. Using GMM, we estimate a pricing kernel that incorporates the effects of financing constraints on investment behavior. The key ingredients in this pricing kernel depend not only on "fundamentals", such as profits and investment, but also on the financing variables, such as default premium and the amount of external financing. Our findings, however, suggest that the role played by financing frictions is fairly negligible, unless the premium on external funds is procyclical a property not evident in the data and not satisfied by most models of costly external finance.

Abstract:
No. Two related variables, the book-to-market spread (the book-to-market of value stocks minus the book-to-market of growth stocks), and the market-to-book spread (the market-to-book of growth stocks minus the market-to-book of value stocks) predict returns but with opposite signs. The value spread mixes the cyclical variations of the book-to-market and market-to-book spreads, and appears much less useful in predicting returns. Our evidence casts doubt on Campbell and Vuolteenaho (2004) because their conclusion relies critically on using the value spread as a predictor of aggregate stock returns.

The Value Spread, Time Series Predictability, Business Cycles

Abstract:
No. Two related variables, the book-to-market spread (the book-to-market of value stocks minus the book-to-market of growth stocks) and the market-to-book spread (the market-to-book of growth stocks minus the market-to-book of value stocks) predict returns but with opposite signs. The value spread mixes the cyclical variations of the book-to-market and market-to-book spreads, and appear much less useful in predicting returns. Our evidence casts doubt on recent studies that rely critically on using the value spread to predict aggregate stock returns.

The Value Spread, Predictability, Business Cycles

Abstract:
Using the Markov switching framework of Perez-Quiros and Timmermann (2000), we show that the expected value-minus-growth returns display strong countercyclical variations. Under a variety of flexibility proxies such as the ratio of fixed assets to total assets, the frequency of disinvestment, financial leverage, and operating leverage, we show that value firms are less flexible in adjusting to worsening economic conditions than growth firms, and that inflexibility increases the costs of equity in the cross section. The time-variation in the expected value premium highlights the importance of conditioning information in understanding the cross section of average returns.

Value stocks, growth stocks, regime switching, time-varying expected returns, real flexibility

Abstract:
This paper revisits the time-series relation between the conditional risk premium and variance of the equity market portfolio. The main innovation is that we construct a measure of the ex ante equity market risk premium using corporate bond yield spread data. This measure is forward-looking and does not rely critically on either realized equity returns or instrumental variables. We find strong support for a positive risk-return tradeoff, and this result is not sensitive to a number of robustness checks, including alternative proxies of the conditional stock variance and controls for hedging demands.

Expected return, equity market volatility, systematic risk, yield spreads

Abstract:
An investment factor, long in low-investment stocks and short in high-investment stocks, helps explain the new issues puzzle. Adding the investment factor into standard factor regressions reduces the SEO underperformance by about 75%, the IPO underperformance by 80%, the underperformance following convertible debt offerings by 50%, and Daniel and Titman's () composite issuance effect by 40%. The reason is that issuers invest more than nonissuers, and the investment factor earns a significantly positive average return of 0.57% per month.

Abstract:
An investment factor, long in low investment stocks and short in high investment stocks, helps explain the new issues puzzle. Adding the investment factor into standard factor regressions reduces on average about 75% of the SEO underperformance, 80% of the IPO underperformance, 50% of the underperformance following convertible debt offerings, and 40% of Daniel and Titman's (2006) composite issuance effect. The reason is that issuers invest more than nonissuers, and the investment factor earns a significantly positive average return of 0.57% per month.

The new issues puzzle, post-issue underperformance, real investment, time-varying expected returns

Abstract:
An investment factor, long in low investment stocks and short in high investment stocks, helps explain the new issues puzzle. Adding this factor into standard factor regressions reduces substantially the magnitude of the underperformance following equity and debt offerings and the composite issuance effect. The reason is that issuers invest more than nonissuers, and the low-minus-high investment factor earns a significant average return of 0.57% per month. Our evidence lends support to the real options theory, in which investment extinguishes risky expansion options, and the q-theory of investment, in which firms with low costs of capital invest more.

The new issues puzzle, post-issue underperformance, real investment, time-varying expected returns

Abstract:
We study the connection between momentum portfolio returns and shifts in factor loadings on the growth rate of industrial production. Winners have temporarily higher loadings than losers. The loading spread derives mostly from the high, positive loadings of winners. Small stocks have higher loadings than big stocks, and value stocks have higher loadings than growth stocks. Using standard multifactor tests, we present evidence that the growth rate of industrial production is a priced risk factor. In most of our tests, however, the combined effect of factor pricing and risk shifts does not explain a large fraction of momentum returns.

Momentum, the growth rate of industrial production, macroeconomic risk, the expected-growth risk

Abstract:
We study empirically the changes in economic fundamentals for firms with recent stock price momentum. We find that: (i) winners have temporarily higher dividend, investment, and sales growth rates, and losers have temporarily lower dividend, investment, and sales growth rates; (ii) the duration of the growth rate dispersion matches approximately that of the momentum profits; (iii) past returns are strong, positive predictors of future growth rates; and (iv) factor-mimicking portfolios on expected growth rates earn significantly positive returns on average. This evidence is consistent with the theoretical predictions of Johnson (2002), in which momentum returns reflect compensation for temporary shifts in risk associated with expected growth. Additional tests do not provide much support for a risk-based explanation, however.

Expected Growth, Momentum, Risk, Event Study

Abstract:
More financially constrained firms are riskier and earn higher expected returns than less financially constrained firms, although this effect can be subsumed by size and book-to-market. Further, because the stochastic discount factor makes capital investment more procyclical, financial constraints are more binding in economic booms. These insights arise from two dynamic models. In Model 1, firms face dividend nonnegativity constraints without any access to external funds. In Model 2, firms can retain earnings, raise debt and equity, but face collateral constraints on debt capacity. Despite their diverse structures, the two models share largely similar predictions.

Abstract:
More financially constrained firms are riskier and earn higher expected returns than less financially constrained firms, although this effect can be subsumed by size and book-to-market. Further, because the stochastic discount factor makes capital investment more procyclical, financial constraints are more binding in economic booms. These insights arise from two dynamic models. In Model 1, firms face dividend nonnegativity constraints without any access to external funds. In Model 2, firms can retain earnings, raise debt and equity, but face collateral constraints on debt capacity. Despite their diverse structures, the two models share largely similar predictions.

Financial constraints, debt capacity, stochastic discount factor, expected returns

Abstract:
The neoclassical q-theory is a good start to understand the cross section of returns. Under constant return to scale, stock returns equal levered investment returns that are tied directly with characteristics. This equation generates the relations of average returns with book-to-market, investment, and earnings surprises. We estimate the model by minimizing the differences between average stock returns and average levered investment returns via GMM. Our model captures well the average returns of portfolios sorted on capital investment and on size and book-to-market, including the small-stock value premium. Our model is also partially successful in capturing the post-earnings-announcement drift and its higher magnitude in small firms.

Abstract:
The neoclassical q-theory is a good start to understand the cross section of returns. Under constant return to scale, stock returns equal levered investment returns that are tied directly with characteristics. This equation generates the relations of average returns with book-to-market, investment, and earnings surprises. We estimate the model by minimizing the differences between average stock returns and average levered investment returns via GMM. Our model captures well the average returns of portfolios sorted on capital investment and on size and book-to-market, including the small-stock value premium. Our model is also partially successful in capturing the post-earnings-announcement drift and its higher magnitude in small firms.

Anomalies, Tobin's Q, time-varying expected returns, rational expectations

Abstract:
We follow Fama and French (2002) in estimating expected returns using growth rates of fundamentals to measure expected rates of capital gain. We study a wide range of anomaly variables including book-to-market, composite issuance, net stock issues, abnormal investment, asset growth, price momentum, earnings surprises, total and discretionary accruals, net operating assets, and failure probability. Our results are striking: In most specifications, the unconditional expected returns and ex ante CAPM alphas of the zero-cost strategies formed on these anomaly variables are indistinguishable from zero. We conclude that anomalies might not exist ex ante.

capital markets anomalies, expected return estimates, ex ante alphas

Abstract:
This Paper asks whether the asset pricing fluctuations induced by the presence of costly external finance are empirically plausible. To accomplish this, we incorporate costly external finance into a dynamic stochastic general equilibrium model and explore its implications for the properties of the returns on key financial assets, such as stocks, bonds and risky loans. We find that the mean and volatility of the equity premium, although small, are significantly higher than those in comparable adjustment cost models. We also show that these results require a procyclical-financing premium, however, a property that seems at odds with the data.

Financial accelerator, business cycles, asset prices

Abstract:
This paper asks whether the asset pricing fluctuations induced by the presence of costly external finance are empirically plausible. To accomplish this, we incorporate costly external finance into a dynamic stochastic general equilibrium model and explore its implications for the properties of the returns on key financial assets, such as stocks, bonds and risky loans. We find that the mean and volatility of the equity premium, although small, are significantly higher than those in comparable adjustment cost models. However, we also show that these results require a procyclical financing premium, a property that seems at odds with the data.

Abstract:
This paper asks whether the asset pricing fluctuations induced by the presence of costly external finance are empirically plausible. To accomplish this, we incorporate costly external finance into a dynamic stochastic general equilibrium model and explore its implications for the properties of the returns on the key financial assets, such as stocks, bonds and risky loans. We find that the mean and volatility of the equity premium is significantly higher than in comparable adjustment cost models. However, we show that these results require a procyclical financing premium, a property that seems at odds with the data.

Costly External Finance, Business Cycles, Default Premium

Abstract:
We use a fully-specified neoclassical model augmented with costly external equity as a laboratory to study the relations between stock returns and equity financing decisions. Simulations show that the model can simultaneously and in many cases quantitatively reproduce: procyclical equity issuance; the negative relation between aggregate equity share and future stock market returns; long-term underperformance following equity issuance and the positive relation of its magnitude with the volume of issuance; the mean-reverting behavior in the operating performance of issuing firms; and the positive long-term stock price drift of firms distributing cash and its positive relation with book-to-market. We conclude that systematic mispricing seems unnecessary to generate the return-related evidence often interpreted as behavioral underreaction to market timing.

Abstract:
We use a fully-specified neoclassical model augmented with costly external equity as a laboratory to study the relations between stock returns and equity financing decisions. Simulations show that the model can simultaneously and in many cases quantitatively reproduce: procyclical equity issuance; the negative relation between aggregate equity share and future stock market returns; long-term underperformance following equity issuance and the positive relation of its magnitude with the volume of issuance; the mean-reverting behavior in the operating performance of issuing firms; and the positive long-term stock price drift of firms distributing cash and its positive relation with book-to-market. We conclude that systematic mispricing seems unnecessary to generate the return-related evidence often interpreted as behavioral underreaction to market timing.

External Finance, Market Timing, Stock Returns, Quantitative Theory, Neoclassical Economics

Abstract:
We study the effect of financial constraints on risk and expected returns by extending the investment-based asset pricing framework to incorporate retained earnings, debt, costly external equity, and collateral constraints on debt capacity. Quantitative results show that more financially constrained firms are riskier and earn higher expected returns than less financially constrained firms. Intuitively, by preventing firms from financing all desired investments, collateral constraints restrict the flexibility of firms in smoothing dividend streams in the face of aggregate shocks. The inflexibility mechanism also gives rise to a convex relation between market leverage and expected returns.

debt capacity, investment-based asset pricing, collateral constraints, the cross-section of expected stock returns

Abstract:
Recent winners have temporarily higher loadings than recent losers on the growth rate of industrial production. The loading spread derives mostly from the positive loadings of winners. The growth rate of industrial production is a priced risk factor in standard asset pricing tests. In many specifications, this macroeconomic risk factor explains more than half of momentum profits. We conclude that risk plays an important role in driving momentum profits.

Momentum, the growth rate of industrial production, macroeconomic risk, the expected-growth risk

Abstract:
Investment-based asset pricing uses the link between stock and investment returns to tie expected returns with firm characteristics. I derive the equivalence between these two returns in the Q-framework with variable capacity utilization, proportional operating costs, irreversible investment, and dividend constraints. With multiple capital goods, stock return is the value-weighted average of individual investment returns. Under time-to-build, I derive the relation between the market value and the marginal q, but no analytical link is available between stock and investment returns.

Investment-based asset pricing, capacity utilization, investment return, capital heterogeneity, time-to-build

Abstract:
We examine the properties of equilibrium stock returns in an incomplete information economy in which agents need to learn the hidden state of the endowment process. Both Bayesian and suboptimal learning rules are considered, including
near-rational learning, conservatism, representativeness, optimism, and pessimism. We demonstrate that Bayesian learning performs reasonably well in producing realistic variation in the conditional equity risk premium, return volatility, and Sharpe ratio. Alternative learning behaviors alter significantly both the level and time-variation of the conditional moments of returns. However, when we allow the agents to be conscious of their learning mistakes and to price assets accordingly, the properties of equilibrium stock returns under alternative learning are virtually indistinguishable from those under Bayesian learning.

Abstract:
We construct firm-specific measures of expected equity returns using corporate bond yields, and replace standard ex-post average returns with our expected-return measures in asset pricing tests. We find that the market beta is significantly priced in the cross-section of expected returns. The expected size and value premia are positive and countercyclical, but there is no evidence of positive expected momentum profits.

Expected returns, risk factors, systematic risk, yield spreads

Abstract:
In a frictionless world, investment is perfectly elastic to changes in the discount rate. With financial frictions, investment is less elastic, meaning that a given magnitude of change in investment is associated with a higher magnitude of change in the discount rate. Equivalently, investment is a more powerful predictor of future stock returns. Consistent with this prediction, we document that the asset growth, external finance, and accrual anomalies in the cross-section of stock returns are much stronger in financially more constrained firms than in financially less constrained firms. Further tests show that this effect of financial constraints is distinct from the effect of financial distress and the effect of limits of arbitrage on the magnitude of the anomalies.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
In a frictionless world, investment is perfectly elastic to changes in the discount rate. With financial frictions, investment is less elastic, meaning that a given magnitude of change in investment is associated with a higher magnitude of change in the discount rate. Equivalently, investment is a more powerful predictor of future stock returns. Consistent with this prediction, we document that the asset growth, external finance, and accrual anomalies in the cross-section of stock returns are much stronger in financially more constrained firms than in financially less constrained firms. Further tests show that this effect of financial constraints is distinct from the effect of financial distress and the effect of limits of arbitrage on the magnitude of the anomalies.

Financial Frictions, Anomalies, Investment-based Asset Pricing

Abstract:
We study the interactions between the stock market and the labor market. When aggregate risk premiums are time-varying, predictive variables for market excess returns should forecast long-horizon growth in the marginal benefit of hiring and thereby long-horizon aggregate employment growth. Consistent with this logic, we document that long-horizon payroll growth and change in unemployment rate are predictable with risk premium proxies. Lagged payroll growth and change in unemployment rate also forecast stock market excess returns.

Time-varying risk premiums, payroll growth, unemployment rate, search and matching, time-to-build

Abstract:
Interpreting accruals as working capital investment, we hypothesize based on q-theory that firms optimally adjust their accruals in response to discount rate changes. A higher discount rate means less profitable investments and lower accruals, and a lower discount rate means more profitable investments and higher accruals. Our evidence supports this optimal investment hypothesis: (i) adding an investment factor into standard factor regressions substantially reduces the magnitude of the accrual anomaly, often to insignificant levels; (ii) accruals covary negatively with discount rate estimates from the dividend discounting model, and for the most part, with estimates from the residual income model; (iii) accruals with low accounting reliability covary more with capital investment than accruals with high accounting reliability; and (iv) expected returns to accruals-based trading strategies are time-varying, suggesting that the deterioration of the accrual effect in recent years might be temporary and likely to mean-revert in the near future.

The accruals anomaly, total accruals, discretionary accruals, net operating assets, investment-based asset pricing, capital investment, time-varying expected returns

Abstract:
We introduce a general purpose data library for empirical capital markets research. This companion document serves several purposes. First, we explain the motivation of the new data library by summarizing the key insights from Chen and Zhang. Second, we provide in a single document all the technical descriptions on portfolio constructions that are available separately through links labeled 'Details' at the library's website. Finally, the COMPUSTAT has recently changed the descriptions of each data item. We use the new COMPUSTAT definitions to describe in details how to construct the q-theory factors and testing portfolios to facilitate the replication of the results reported in our forthcoming article.

Anomalies, alpha, q-theory, factor regression, investment-based asset pricing

Abstract:
We derive and test q-theory implications for cross-sectional stock returns. Under constant returns to scale, stock returns equal levered investment returns, which are tied directly to firm characteristics. When we use GMM to match average levered investment returns to average observed stock returns, the model captures the average stock returns of portfolios sorted by earnings surprises, book-to-market equity, and capital investment. When we try to match expected returns and return variances simultaneously, the variances predicted in the model are largely comparable to those observed in the data. However, the resulting expected return errors are large.

q-theory, the cross-section of expected returns, investment-based asset pricing, stock return volatility, structural estimation

Abstract:
We document that the value, net stock issues, investment, and asset growth anomalies are stronger in financially more constrained firms than in financially less constrained firms. This effect is distinct from the impact of financial distress on anomalies. An investment-based asset pricing model predicts that costly external finance makes marginal costs of investment more sensitive to investment in financially more constrained firms. This effect gives rise to a stronger negative correlation between investment and the discount rate in more constrained firms.

financial constraints, financial distress, anomalies

Abstract:
Recent studies have used the value spread to predict aggregate stock returns to construct cash-flow betas that appear to explain the size and value anomalies. We show that two related variables, the book-to-market spread (the book-to-market of value stocks minus that of growth stocks) and the market-to-book spread (the market-to-book of growth stocks minus that of value stocks) predict returns in different directions and exhibit opposite cyclical variations. Most important, the value spread mixes information on the book-to-market and market-to-book spreads, and appears much less useful in predicting returns.

Abstract:
Building on neoclassical reasoning, we propose a new multi-factor model that consists of the market factor and factor mimicking portfolios based on investment and productivity. The neo- classical three-factor model outperforms traditional factor models in explaining the average returns across testing portfolios formed on momentum, financial distress, investment, profitability, accruals, net stock issues, earnings surprises, and asset growth. Most intriguingly, winners have higher loadings than losers on both the low-minus-high investment factor and the high- minus-low productivity factor, which in turn help explain momentum profits.

Abstract:
Previous work shows that the growth rate of industrial production is a common macroeconomic risk factor in the cross-section of expected returns. We demonstrate the connection between momentum profits and shifts in factor loadings on this macroeconomic variable. Winners have temporarily higher loadings on the growth rate of industrial production than losers. The loading dispersion derives mostly from the high, positive loadings of winners. Depending on model specification, this loading dispersion can explain up to 40% of momentum profits.

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Abstract:
Adding a return factor based on capital investment into standard, calendar-time factor regressions makes underperformance following seasoned equity offerings largely insignificant and reduces its magnitude by 37-46%. The reason is that issuers invest more than nonissuers matched on size and book-to-market. Moreover, the low-minus-high investment-to-asset factor earns a significant average return of 0.37% per month. Our evidence suggests that the underperformance results from the negative investment-expected return relation, as predicted by Carlson, Fisher, and Giammarino (2005).

Abstract:
We study the interactions between the stock market and the labor market. When aggregate risk premiums are time-varying, predictive variables for market excess returns should forecast long-horizon growth in the marginal benefit of hiring and thereby long-horizon aggregate employment growth. Consistent with this logic, we document that long-horizon payroll growth and change in unemployment rate are predictable with risk premium proxies. Lagged payroll growth and change in unemployment rate also forecast stock market excess returns.

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Abstract:
Recent winners have temporarily higher loadings than recent losers on the growth rate of industrial production. The loading spread derives mostly from the positive loadings of winners. The growth rate of industrial production is a priced risk factor in standard asset pricing tests. In many specifications, this macroeconomic risk factor explains more than half of momentum profits. We conclude that risk plays an important role in driving momentum profits.

G12, E44

Abstract:
We construct a dynamic general equilibrium production economy to explicitly link expected stock returns to firm characteristics such as firm size and the book-to-market ratio. Stock returns in the model are completely characterized by a conditional CAPM. Size and book-to-market are correlated with the true conditional market beta and therefore appear to predict stock returns. The cross-sectional relations between firm characteristics and returns can subsist even after one controls for typical empirical estimates of beta. These findings suggest that the empirical success of size and book-to-market can be consistent with a single-factor conditional CAPM model.

Asset Pricing, Stock Returns, Book-to-market, Size, Equilibrium, Cross-section, Production, Investment, Business Cycle, Aggregation, Heterogeneity