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Optimal Investment, Growth Options, and Security Returns

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Author Info
Jonathan B. Berk (University of California, Berkeley, and NBER,)
Richard C. Green (Carnegie Mellon University,)
Vasant Naik (University of British Columbia)
Abstract

As a consequence of optimal investment choices, a firm's assets and growth options change in predictable ways. Using a dynamic model, we show that this imparts predictability to changes in a firm's systematic risk, and its expected return. Simulations show that the model simultaneously reproduces: (i) the time-series relation between the book-to-market ratio and asset returns; (ii) the cross-sectional relation between book-to-market, market value, and return; (iii) contrarian effects at short horizons; (iv) momentum effects at longer horizons; and (v) the inverse relation between interest rates and the market risk premium. Copyright The American Finance Association 1999.

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Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 54 (1999)
Issue (Month): 5 (October)
Pages: 1553-1607
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Handle: RePEc:bla:jfinan:v:54:y:1999:i:5:p:1553-1607

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  15. James Dow & Gary Gorton & Arvind Krishnamurthy, 2005. "Equilibrium Investment and Asset Prices under Imperfect Corporate Control," American Economic Review, American Economic Association, vol. 95(3), pages 659-681, June. [Downloadable!]
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  17. Tano Santos & Pietro Veronesi, 2004. "Conditional Betas," NBER Working Papers 10413, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  18. Matthew Rabin., 2000. "Inference by Believers in the Law of Small Numbers," Economics Working Papers E00-282, University of California at Berkeley. [Downloadable!]
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