The Investment-Return Relation

Abstract

The q-theory of asset pricing predicts a negative relation between a firm’s investment and its future stock returns, and the negative relation is stronger among firms with higher investment frictions. These predictions arise from each firm’s decision. Therefore, testing it does not require that the amount of investment be in investors’ information set, and skipping between the investment and future stock returns is unnecessary. We document a positive relation between a firm’s investment and its immediate future stock returns. This positive relation, in most empirical specifications, fully subsumes the traditionally documented negative investment-return relation that starts several quarters after investment. After considering immediate future returns, the investment-return relation is more positive among firms with higher investment frictions. These findings challenge the q-theory based interpretation of the investment-return relation.

Keywords: q-factor model; q theory; investment CAPM; asset pricing; stock returns; cross section

JEL Classification: G12; G41; G14