Disentangling Investment Returns and Stock Returns: The Importance of Time-to-Build

43 Pages Posted: 7 Mar 2007 Last revised: 21 Oct 2009

See all articles by Lars-Alexander Kuehn

Lars-Alexander Kuehn

Carnegie Mellon University - David A. Tepper School of Business

Date Written: March 5, 2009

Abstract

I provide new evidence on the failure of the Q-theory. The Q-theory implies the state-by-state equivalence of stock and investment returns -- a important implication of many asset pricing models. Using aggregate US data, I find there exists a realistic parameterization of the aggregate production and adjustment cost function such that empirical investment returns have first and second moments similar to historical US stock returns. Investment and stock returns are negatively correlated, however, contradicting the Q-theory. This paper also proposes a rational explanation for this finding. A general equilibrium model with production, in which investment projects involve time-to-build, can rationalize these findings. The model is also able to explain the negative correlation of investment growth and stock returns at the aggregate level -- an observation that has been interpreted as evidence for irrational markets since it cannot be reconciled with the Q-theory of investment.

Keywords: Real investments, time-to-build, excess returns, investment returns

JEL Classification: E32, G12

Suggested Citation

Kuehn, Lars-Alexander, Disentangling Investment Returns and Stock Returns: The Importance of Time-to-Build (March 5, 2009). EFA 2007 Ljubljana Meetings Paper; AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=968333 or http://dx.doi.org/10.2139/ssrn.968333

Lars-Alexander Kuehn (Contact Author)

Carnegie Mellon University - David A. Tepper School of Business ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

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