The Investment Opportunity Set and its Proxy Variables

42 Pages Posted: 23 Jan 2002 Last revised: 28 Sep 2008

See all articles by Tim Adam

Tim Adam

Humboldt University

Vidhan K. Goyal

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Date Written: August 6, 2007

Abstract

We use a real options approach to evaluate the performance of proxy variables for a firm¿s investment opportunity set. The results show that on a relative scale, the market-to-book assets ratio outperforms all other proxy variables that we investigate. It has the highest information content with respect to investment opportunities, and it is least affected by other factors. Although both the market-to-book equity and the earnings-price ratios are related to investment opportunities, they do not contain information that is not already contained in the market-to-book assets ratio. Consistent with this finding, a common factor constructed from several proxy variables does not improve the performance of the market-to-book assets ratio.

Keywords: Proxy variables, investment opportunity set, growth opportunities, real options, market-to-book ratios, mining industry, financial constraints

JEL Classification: G31, D92, L72, C52

Suggested Citation

Adam, Tim and Goyal, Vidhan K., The Investment Opportunity Set and its Proxy Variables (August 6, 2007). Available at SSRN: https://ssrn.com/abstract=298048 or http://dx.doi.org/10.2139/ssrn.298048

Tim Adam

Humboldt University ( email )

Dorotheentr. 1
Berlin, Berlin 10099
Germany
+49 (0)30 2093-5641 (Phone)
+49 (0)30 2093-5643 (Fax)

Vidhan K. Goyal (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong
852-2358-7678 (Phone)
852-2358-1749 (Fax)

HOME PAGE: http://www.vidhangoyal.com

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