Limits‐To‐Arbitrage, Investment Frictions, and the Investment Effect: New Evidence

41 Pages Posted: 19 May 2020

See all articles by FY Eric Lam

FY Eric Lam

Hong Kong Monetary Authority - Hong Kong Institute for Monetary Research (HKIMR)

Ya LI

The Open University of Hong Kong

Wikrom Prombutr

California State University, Long Beach

K.C. John Wei

Hong Kong Polytechnic University

Multiple version iconThere are 2 versions of this paper

Date Written: January 2020

Abstract

This study comprehensively reexamines the debate over behavioral and rational explanations for the investment effect in an updated sample. We closely follow the previous literature and provide several differences. Our tests include five prominent measures of corporate investment and corporate profitability in q‐theory and recent investment‐based asset pricing models. Both classical and Bayesian inferences show that limits‐to‐arbitrage tend to be supported by more evidence than investment frictions for all investment measures. When idiosyncratic volatility and cash flow volatility are used in measuring investment frictions, the inference is more favorable for the rational explanation.

Keywords: investment, investment frictions, limits‐to‐arbitrage, q‐theory, stock returns

Suggested Citation

Lam, Full Yet Eric Campbell and LI, Ya and Prombutr, Wikrom and Wei, Kuo-Chiang (John), Limits‐To‐Arbitrage, Investment Frictions, and the Investment Effect: New Evidence (January 2020). European Financial Management, Vol. 26, Issue 1, pp. 3-43, 2020, Available at SSRN: https://ssrn.com/abstract=3600288 or http://dx.doi.org/10.1111/eufm.12216

Full Yet Eric Campbell Lam (Contact Author)

Hong Kong Monetary Authority - Hong Kong Institute for Monetary Research (HKIMR) ( email )

55/F, Two International Finance Centre,
8 Finance Street, Central
Hong Kong
China

Ya LI

The Open University of Hong Kong ( email )

30 Good Shepherd Street, Ho Man Tin
Hong Kong

Wikrom Prombutr

California State University, Long Beach ( email )

1250 Bellflower Blvd
Long Beach, CA 90064
United States

Kuo-Chiang (John) Wei

Hong Kong Polytechnic University ( email )

11 Yuk Choi Rd
Hung Hom
Hong Kong

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