Asset Pricing Implications of Non-Convex Adjustment Costs and Irreversibility of Investment

44 Pages Posted: 25 Jul 2003

See all articles by Ilan Cooper

Ilan Cooper

BI Norwegian Business School

Date Written: October 2003

Abstract

This paper derives a real options model that accounts for the value premium in stock returns. If real investment is largely irreversible, the book value of a distressed firm is high relative to its market value because it has idle physical capital. The firm's excess installed capital capacity enables it to easily expand production in response to positive aggregate shocks. Thus, returns to equity holders of a high book-to-market firm are sensitive to aggregate conditions and its systematic risk is high. Simulations indicate that the model goes a long way toward accounting for the observed value premium.

Suggested Citation

Cooper, Ilan, Asset Pricing Implications of Non-Convex Adjustment Costs and Irreversibility of Investment (October 2003). Available at SSRN: https://ssrn.com/abstract=423923 or http://dx.doi.org/10.2139/ssrn.423923

Ilan Cooper (Contact Author)

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

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