Profitability and Stock Returns in Production-Based Asset Pricing with Decreasing Returns to Scale

51 Pages Posted: 16 Jun 2013 Last revised: 6 Jul 2013

See all articles by Ronald J. Balvers

Ronald J. Balvers

McMaster University - Michael G. DeGroote School of Business

Li Gu

Federal Reserve Board

Dayong Huang

University of North Carolina (UNC) at Greensboro - Bryan School of Business & Economics

Date Written: June 20, 2013

Abstract

Production decisions provide a credible indicator of future costs of capital perceived by corporate insiders and so may forecast future stock returns. We find that, under decreasing returns to scale, investment returns correlate imperfectly with stock returns and that higher profitability and traditional value are both associated with higher chosen risk exposure. Capital investment and utilization predict profitability and future returns. Empirically, utilization approximated by electricity usage has clear forecast power for returns, complementing the established forecast power of investment. In addition, book-to-market ratios forecast returns, with specific predicted exceptions. The production-based model with decreasing returns predicts costs of capital better than traditional asset pricing models.

Keywords: Profitability, Stock returns, Production-based asset pricing, Investment returns, Capacity utilization, Decreasing returns to scale

JEL Classification: G12

Suggested Citation

Balvers, Ronald J. and Gu, Li and Huang, Dayong, Profitability and Stock Returns in Production-Based Asset Pricing with Decreasing Returns to Scale (June 20, 2013). Available at SSRN: https://ssrn.com/abstract=2279622 or http://dx.doi.org/10.2139/ssrn.2279622

Ronald J. Balvers

McMaster University - Michael G. DeGroote School of Business ( email )

1280 Main Street West
Hamilton, Ontario L8S 4M4
Canada
(905) 525-9140 x23969 (Phone)

HOME PAGE: http://profs.degroote.mcmaster.ca/business/balvers

Li Gu (Contact Author)

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Dayong Huang

University of North Carolina (UNC) at Greensboro - Bryan School of Business & Economics ( email )

401 Bryan Building
Greensboro, NC 27402-6179
United States

HOME PAGE: http://sites.google.com/a/uncg.edu/dayong-huang/

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