Costly External Finance: Implications for Capital Markets Anomalies

46 Pages Posted: 1 Jul 2008 Last revised: 16 Sep 2009

See all articles by Dongmei Li

Dongmei Li

University of South Carolina - Darla Moore School of Business - Department of Finance

Lu Zhang, 张橹

Ohio State University - Fisher College of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: May 4, 2009

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.

Keywords: Financial Frictions, Anomalies, Investment-based Asset Pricing

JEL Classification: E22, E44, G12, G14, G31, G32

Suggested Citation

Li, Dongmei and Zhang, Lu, Costly External Finance: Implications for Capital Markets Anomalies (May 4, 2009). Ross School of Business Paper No. 1111. Available at SSRN: https://ssrn.com/abstract=1154002 or http://dx.doi.org/10.2139/ssrn.1154002

Dongmei Li

University of South Carolina - Darla Moore School of Business - Department of Finance ( email )

1014 Greene Street
Columbia, SC 29208
United States

Lu Zhang (Contact Author)

Ohio State University - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
585-267-6250 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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