The Great Divorce Between Investment and Profitability: Implications for Asset Pricing

61 Pages Posted: 24 Sep 2019 Last revised: 25 Oct 2021

See all articles by Mete Kilic

Mete Kilic

University of Southern California - Marshall School of Business

Louis Yang

Cubist Systematic Strategies

Miao Ben Zhang

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Date Written: May 18, 2021

Abstract

Using data over the last century, we show that the cross-sectional relation between investment and profitability among U.S. public firms is positive in the first half-century but negative in the recent four decades. The negative fundamental relation explains the high level and the positive correlation of investment and profitability premiums after 1980. In out-of-sample environments including the pre-1980 U.S. stock market where investment and profitability premiums are low and insignificant, the fundamental relation is positive. Given the time-varying investment-profitability correlation, both the in and out-of-sample behaviors of investment and profitability premiums are consistent with the neoclassical investment framework.

Keywords: Neoclassical Investment Theory; Cross-Section of Stock Returns; Investment Premium; Profitability Premium; Out-of-Sample Test.

JEL Classification: G10, G12, G31, D92

Suggested Citation

Kilic, Mete and Yang, Louis and Zhang, Miao Ben, The Great Divorce Between Investment and Profitability: Implications for Asset Pricing (May 18, 2021). Available at SSRN: https://ssrn.com/abstract=3447685 or http://dx.doi.org/10.2139/ssrn.3447685

Mete Kilic

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA California 90089
United States

Louis Yang

Cubist Systematic Strategies ( email )

55 Hudson Yards
10th Floor
New York, NY 10001
United States

Miao Ben Zhang (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

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

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