Implied Asset Return Profiles, Firm Fundamentals, and Stock Returns

71 Pages Posted: 2 Mar 2021 Last revised: 22 Feb 2022

See all articles by Jongsub Lee

Jongsub Lee

Seoul National University; University of Florida - Warrington College of Business Administration

Andy Naranjo

University of Florida

Stace Sirmans

Auburn University

Date Written: February 14, 2022

Abstract

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

Lee, Jongsub and Naranjo, Andy and Sirmans, Stace, Implied Asset Return Profiles, Firm Fundamentals, and Stock Returns (February 14, 2022). Available at SSRN: https://ssrn.com/abstract=3795783 or http://dx.doi.org/10.2139/ssrn.3795783

Jongsub Lee (Contact Author)

Seoul National University ( email )

Kwanak-gu
Seoul, 151-742
Korea, Republic of (South Korea)

University of Florida - Warrington College of Business Administration ( email )

Department of Finance Insurance & Real Estate
P.O. Box 117168
Gainesville, FL 32611-7168
United States
352-273-4966 (Phone)
352-392-0301 (Fax)

Andy Naranjo

University of Florida ( email )

Gainesville, FL
United States

Stace Sirmans

Auburn University ( email )

Auburn, AL 36849
United States

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

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