Returns to Equity, Investment and Q: Evidence from the United Kingdom

35 Pages Posted: 27 Feb 2007

See all articles by Simon Price

Simon Price

City University London - Department of Economics; Essex Business School

Christoph Schleicher

Bank of England

Date Written: October 2006


Conventional wisdom has it that Tobin's Q cannot help explain aggregate investment. This is puzzling, as recent evidence suggests the closely related user cost approach can do so. We do not attempt to explain this puzzle. Instead, we take an entirely different approach, not using the first-order conditions from the firm's maximisation problem but instead exploiting the present-value expression for the firm's value. The standard linearised present-value asset price decomposition suggests that Q should be able to predict other variables, such as stock returns. Using UK data we find that it has strong long-horizon predictive power for debt accumulation, stock returns and UK business investment. The correctly signed results on both returns and investment appear to be robust, and are supported by the commonly used and bootstrapped standard error corrections, as well as recently developed asymptotic corrections.

Keywords: Investment, Tobin's Q, long-horizon forecasting

JEL Classification: E22, E27

Suggested Citation

Price, Simon G. and Price, Simon G. and Schleicher, Christoph, Returns to Equity, Investment and Q: Evidence from the United Kingdom (October 2006). Bank of England Working Paper No. 310, Available at SSRN: or

Simon G. Price (Contact Author)

City University London - Department of Economics ( email )

Northampton Square
London, EC1V 0HB
United Kingdom

Essex Business School ( email )

Wivenhoe Park
Colchester, CO4 3SQ
United Kingdom

Christoph Schleicher

Bank of England ( email )

Threadneedle Street
London EC2R 8AH
United Kingdom
+44 0207 601 4115 (Phone)
+44 0207 601 5953 (Fax)

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