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Corporate Investment and Asset Price Dynamics: Implications for the Cross-Section of Returns

37 Pages Posted: 10 Jun 2003  

Murray Carlson

University of British Columbia (UBC) - Sauder School of Business

Adlai J. Fisher

University of British Columbia (UBC) - Sauder School of Business

Ron Giammarino

University of British Columbia (UBC) - Sauder School of Business

Date Written: May 7, 2003

Abstract

We show that corporate investment decisions can explain conditional dynamics in expected asset returns. Our approach is similar in spirit to Berk, Green, and Naik (1999), but we introduce to the investment problem operating leverage, reversible real options, fixed adjustment costs, and finite growth opportunities. We assume constant revenue betas, but still obtain asset betas that vary through time as a reflection of historical investment decisions and product market demand. Book-to-market effects emerge and relate to operating leverage, while size captures the importance of growth options relative to assets in place. We first develop these results in a simple setting that permits closed-form solutions. Next, we empirically evaluate a more realistic specification that is solved numerically and estimated using simulated method of moments. This provides new quantitative evidence on the importance of
operating leverage and growth options to the cross-section of returns.

Keywords: Cross-Section of Returns, Size Effect, Book-to-Market Effect, Corporate Investment, Real Options, Simulated Method of Moments

JEL Classification: G12

Suggested Citation

Carlson, Murray and Fisher, Adlai J. and Giammarino, Ron, Corporate Investment and Asset Price Dynamics: Implications for the Cross-Section of Returns (May 7, 2003). AFA 2004 San Diego Meetings; Sauder School of Business Working Paper. Available at SSRN: https://ssrn.com/abstract=408140 or http://dx.doi.org/10.2139/ssrn.408140

Murray D. Carlson

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-822-8358 (Phone)

Adlai J. Fisher (Contact Author)

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver, BC V6T 1Z2
Canada
604-822-8331 (Phone)
604-822-4695 (Fax)

HOME PAGE: http://finance.sauder.ubc.ca/~fisher

Ronald Giammarino

University of British Columbia (UBC) - Sauder School of Business ( email )

2053 Main Mall
Vancouver BC V6T 1Z2
Canada
604-822-8357 (Phone)
604-822-4695 (Fax)

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