Implied Asset Return Profiles, Firm Fundamentals, and Stock Returns
71 Pages Posted: 2 Mar 2021 Last revised: 22 Feb 2022
Date Written: February 14, 2022
We introduce a novel approach to ascertain firms’ unobserved asset return distribution implied by the joint pricing of equity and credit securities within a structural framework. Motivated by Q-theory, we propose a two-factor model that captures asset growth and risk-shifting effects on stock returns. We show that strong asset returns representing systematic growth options predict higher stock returns, whereas shifting risk from equity to credit forecasts lower stock returns. We also find that the performance of many popular stock market factors (that overlook the optionality of equity) are significantly improved after controlling for asset-level risk-shifting exposure.
Keywords: Implied asset return and volatility, joint pricing of equity and credit, option pricing, asset growth and risk-shifting factors, asset prices, market predictability
JEL Classification: G11, G12, G14, G17
Suggested Citation: Suggested Citation