IDEAS home Printed from https://ideas.repec.org/a/eee/jbfina/v44y2014icp219-232.html
   My bibliography  Save this article

Is the investment factor a proxy for time-varying investment opportunities? The US and international evidence

Author

Listed:
  • Huang, Lin
  • Wang, Zijun

Abstract

Motivated from Fama’s (1991) conjecture of an explicit link between the cross-sectional and time-series stock return predictability, we investigate whether the investment factor constructed from the cross-section of stocks also has time-series predictive power for stock returns within Merton’s (1973) ICAPM framework. The evidence from both US and other G-7 countries (except Japan) suggests that the investment factor is a proxy for time-varying investment opportunities. We also find that the risk-return relation is positive and statistically significant after controlling for the covariance between the market factor and the investment factor.

Suggested Citation

  • Huang, Lin & Wang, Zijun, 2014. "Is the investment factor a proxy for time-varying investment opportunities? The US and international evidence," Journal of Banking & Finance, Elsevier, vol. 44(C), pages 219-232.
    • Handle: RePEc:eee:jbfina:v:44:y:2014:i:c:p:219-232
    DOI: 10.1016/j.jbankfin.2014.04.016
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0378426614001423
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jbankfin.2014.04.016?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Wayne E. Ferson & Campbell R. Harvey, 1999. "Conditioning Variables and the Cross Section of Stock Returns," Journal of Finance, American Finance Association, vol. 54(4), pages 1325-1360, August.
    2. Gregory R. Duffee, 2005. "Time Variation in the Covariance between Stock Returns and Consumption Growth," Journal of Finance, American Finance Association, vol. 60(4), pages 1673-1712, August.
    3. Malcolm Baker & Jeremy C. Stein & Jeffrey Wurgler, 2003. "When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms," The Quarterly Journal of Economics, Oxford University Press, vol. 118(3), pages 969-1005.
    4. Eugene F. Fama & Kenneth R. French, 1998. "Value versus Growth: The International Evidence," Journal of Finance, American Finance Association, vol. 53(6), pages 1975-1999, December.
    5. Jagannathan, Ravi & Wang, Zhenyu, 1996. "The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, vol. 51(1), pages 3-53, March.
    6. Nyberg, Henri, 2012. "Risk-Return Tradeoff in U.S. Stock Returns over the Business Cycle," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 47(1), pages 137-158, February.
    7. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(1), pages 122-150, February.
    8. repec:cup:jfinqa:v:46:y:2011:i:06:p:1651-1682_00 is not listed on IDEAS
    9. Abhakorn, Pongrapeeporn & Smith, Peter N. & Wickens, Michael R., 2013. "What do the Fama–French factors add to C-CAPM?," Journal of Empirical Finance, Elsevier, vol. 22(C), pages 113-127.
    10. Hui Guo & Robert F. Whitelaw, 2006. "Uncovering the Risk–Return Relation in the Stock Market," Journal of Finance, American Finance Association, vol. 61(3), pages 1433-1463, June.
    11. Stein, Jeremy C, 1996. "Rational Capital Budgeting in an Irrational World," The Journal of Business, University of Chicago Press, vol. 69(4), pages 429-455, October.
    12. Laura Xiaolei Liu & Toni M. Whited & Lu Zhang, 2009. "Investment-Based Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 117(6), pages 1105-1139, December.
    13. John T. Scruggs, 1998. "Resolving the Puzzling Intertemporal Relation between the Market Risk Premium and Conditional Market Variance: A Two-Factor Approach," Journal of Finance, American Finance Association, vol. 53(2), pages 575-603, April.
    14. Lewellen, Jonathan & Nagel, Stefan & Shanken, Jay, 2010. "A skeptical appraisal of asset pricing tests," Journal of Financial Economics, Elsevier, vol. 96(2), pages 175-194, May.
    15. Campbell, John Y., 1987. "Stock returns and the term structure," Journal of Financial Economics, Elsevier, vol. 18(2), pages 373-399, June.
    16. Bekaert, Geert & Engstrom, Eric & Xing, Yuhang, 2009. "Risk, uncertainty, and asset prices," Journal of Financial Economics, Elsevier, vol. 91(1), pages 59-82, January.
    17. Pastor, Lubos & Stambaugh, Robert F., 2003. "Liquidity Risk and Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 111(3), pages 642-685, June.
    18. Martin Lettau & Sydney Ludvigson, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 815-849, June.
    19. Michael J. Cooper & Huseyin Gulen & Michael J. Schill, 2008. "Asset Growth and the Cross‐Section of Stock Returns," Journal of Finance, American Finance Association, vol. 63(4), pages 1609-1651, August.
    20. Fama, Eugene F. & French, Kenneth R., 2012. "Size, value, and momentum in international stock returns," Journal of Financial Economics, Elsevier, vol. 105(3), pages 457-472.
    21. John Y. Campbell & Tuomo Vuolteenaho, 2004. "Bad Beta, Good Beta," American Economic Review, American Economic Association, vol. 94(5), pages 1249-1275, December.
    22. Murray Carlson & Adlai Fisher & Ron Giammarino, 2004. "Corporate Investment and Asset Price Dynamics: Implications for the Cross-section of Returns," Journal of Finance, American Finance Association, vol. 59(6), pages 2577-2603, December.
    23. Guo, Hui & Savickas, Robert & Wang, Zijun & Yang, Jian, 2009. "Is the Value Premium a Proxy for Time-Varying Investment Opportunities? Some Time-Series Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(1), pages 133-154, February.
    24. Ghysels, Eric & Santa-Clara, Pedro & Valkanov, Rossen, 2005. "There is a risk-return trade-off after all," Journal of Financial Economics, Elsevier, vol. 76(3), pages 509-548, June.
    25. Fama, Eugene F, 1991. "Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-1617, December.
    26. Joao Gomes & Leonid Kogan & Lu Zhang, 2003. "Equilibrium Cross Section of Returns," Journal of Political Economy, University of Chicago Press, vol. 111(4), pages 693-732, August.
    27. Frederico Belo & Xiaoji Lin, 2012. "The Inventory Growth Spread," Review of Financial Studies, Society for Financial Studies, vol. 25(1), pages 278-313.
    28. Berglof, Erik & Perotti, Enrico, 1994. "The governance structure of the Japanese financial keiretsu," Journal of Financial Economics, Elsevier, vol. 36(2), pages 259-284, October.
    29. Martin Lettau & Sydney Ludvigson, 2001. "Resurrecting the (C)CAPM: A Cross-Sectional Test When Risk Premia Are Time-Varying," Journal of Political Economy, University of Chicago Press, vol. 109(6), pages 1238-1287, December.
    30. Cooper, Ilan & Priestley, Richard, 2011. "Real investment and risk dynamics," Journal of Financial Economics, Elsevier, vol. 101(1), pages 182-205, July.
    31. Stefan Nagel & Kenneth J. Singleton, 2011. "Estimation and Evaluation of Conditional Asset Pricing Models," Journal of Finance, American Finance Association, vol. 66(3), pages 873-909, June.
    32. Kent Daniel & Sheridan Titman & K.C. John Wei, 2001. "Explaining the Cross‐Section of Stock Returns in Japan: Factors or Characteristics?," Journal of Finance, American Finance Association, vol. 56(2), pages 743-766, April.
    33. Yu, Jianfeng & Yuan, Yu, 2011. "Investor sentiment and the mean-variance relation," Journal of Financial Economics, Elsevier, vol. 100(2), pages 367-381, May.
    34. Ferris, Stephen P. & Kumar, Raman & Sarin, Atulya, 1995. "The role of corporate groupings in controlling agency conflicts: The case of keiretsu," Pacific-Basin Finance Journal, Elsevier, vol. 3(2-3), pages 319-335, July.
    35. Lipson, Marc L. & Mortal, Sandra & Schill, Michael J., 2011. "On the Scope and Drivers of the Asset Growth Effect," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 46(6), pages 1651-1682, December.
    36. Lin, Xiaoji & Zhang, Lu, 2013. "The investment manifesto," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 351-366.
    37. David Hirshleifer & Kewei Hou & Siew Hong Teoh, 2012. "The Accrual Anomaly: Risk or Mispricing?," Management Science, INFORMS, vol. 58(2), pages 320-335, February.
    38. Sheridan Titman & K.C. John Wei & Feixue Xie, 2009. "Capital Investments and Stock Returns in Japan," International Review of Finance, International Review of Finance Ltd., vol. 9(1‐2), pages 111-131, March.
    39. Xueping Wu & Lily Li Xu, 2005. "The Value Information of Financing Decisions and Corporate Governance during and after the Japanese Deregulation," The Journal of Business, University of Chicago Press, vol. 78(1), pages 243-280, January.
    40. Takeo Hoshi & Anil Kashyap & David Scharfstein, 1991. "Corporate Structure, Liquidity, and Investment: Evidence from Japanese Industrial Groups," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 106(1), pages 33-60.
    41. John H. Cochrane, 2011. "Presidential Address: Discount Rates," Journal of Finance, American Finance Association, vol. 66(4), pages 1047-1108, August.
    42. Jonathan B. Berk & Richard C. Green & Vasant Naik, 1999. "Optimal Investment, Growth Options, and Security Returns," Journal of Finance, American Finance Association, vol. 54(5), pages 1553-1607, October.
    43. Lieven Baele, 2010. "The Determinants of Stock and Bond Return Comovements," The Review of Financial Studies, Society for Financial Studies, vol. 23(6), pages 2374-2428, June.
    44. Jin (Ginger) Wu & Lu Zhang & X. Frank Zhang, 2010. "The q‐Theory Approach to Understanding the Accrual Anomaly," Journal of Accounting Research, Wiley Blackwell, vol. 48(1), pages 177-223, March.
    45. Ron Giammarino & Murray Carlson & Adlai Fisher, 2004. "Corporate Investment and Asset Price Dynamics: Implications for Post-SEO Performance," 2004 Meeting Papers 812, Society for Economic Dynamics.
    46. Scruggs, John T. & Glabadanidis, Paskalis, 2003. "Risk Premia and the Dynamic Covariance between Stock and Bond Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 38(2), pages 295-316, June.
    47. Kang, Jun-Koo & Stulz, Rene M, 2000. "Do Banking Shocks Affect Borrowing Firm Performance? An Analysis of the Japanese Experience," The Journal of Business, University of Chicago Press, vol. 73(1), pages 1-23, January.
    48. Yuhang Xing, 2008. "Interpreting the Value Effect Through the Q-Theory: An Empirical Investigation," Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1767-1795, July.
    49. González, Mariano & Nave, Juan & Rubio, Gonzalo, 2012. "The Cross Section of Expected Returns with MIDAS Betas," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 47(1), pages 115-135, February.
    50. Ghysels, Eric & Santa-Clara, Pedro & Valkanov, Rossen, 2006. "Predicting volatility: getting the most out of return data sampled at different frequencies," Journal of Econometrics, Elsevier, vol. 131(1-2), pages 59-95.
    51. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    52. Kroner, Kenneth F & Ng, Victor K, 1998. "Modeling Asymmetric Comovements of Asset Returns," Review of Financial Studies, Society for Financial Studies, vol. 11(4), pages 817-844.
    53. Christopher W. Anderson & Luis Garcia‐Feijóo, 2006. "Empirical Evidence on Capital Investment, Growth Options, and Security Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 171-194, February.
    54. Lu Zhang, 2005. "The Value Premium," Journal of Finance, American Finance Association, vol. 60(1), pages 67-103, February.
    55. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
    56. Malcolm Baker & Jeffrey Wurgler, 2002. "Market Timing and Capital Structure," Journal of Finance, American Finance Association, vol. 57(1), pages 1-32, February.
    57. Titman, Sheridan & Wei, K. C. John & Xie, Feixue, 2004. "Capital Investments and Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(4), pages 677-700, December.
    58. Richardson, Scott & Tuna, Irem & Wysocki, Peter, 2010. "Accounting anomalies and fundamental analysis: A review of recent research advances," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 410-454, December.
    59. Watanabe, Akiko & Xu, Yan & Yao, Tong & Yu, Tong, 2013. "The asset growth effect: Insights from international equity markets," Journal of Financial Economics, Elsevier, vol. 108(2), pages 529-563.
    60. Evgeny Lyandres & Le Sun & Lu Zhang, 2008. "The New Issues Puzzle: Testing the Investment-Based Explanation," Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2825-2855, November.
    61. Cochrane, John H, 1996. "A Cross-Sectional Test of an Investment-Based Asset Pricing Model," Journal of Political Economy, University of Chicago Press, vol. 104(3), pages 572-621, June.
    62. Petkova, Ralitsa & Zhang, Lu, 2005. "Is value riskier than growth?," Journal of Financial Economics, Elsevier, vol. 78(1), pages 187-202, October.
    63. Qing Li & Maria Vassalou & Yuhang Xing, 2006. "Sector Investment Growth Rates and the Cross Section of Equity Returns," The Journal of Business, University of Chicago Press, vol. 79(3), pages 1637-1665, May.
    64. Cochrane, John H, 1991. "Production-Based Asset Pricing and the Link between Stock Returns and Economic Fluctuations," Journal of Finance, American Finance Association, vol. 46(1), pages 209-237, March.
    65. John H. Cochrane, 2011. "Discount Rates," NBER Working Papers 16972, National Bureau of Economic Research, Inc.
    66. Lanne, Markku & Saikkonen, Pentti, 2006. "Why is it so difficult to uncover the risk-return tradeoff in stock returns?," Economics Letters, Elsevier, vol. 92(1), pages 118-125, July.
    67. Bali, Turan G., 2008. "The intertemporal relation between expected returns and risk," Journal of Financial Economics, Elsevier, vol. 87(1), pages 101-131, January.
    68. Lundblad, Christian, 2007. "The risk return tradeoff in the long run: 1836-2003," Journal of Financial Economics, Elsevier, vol. 85(1), pages 123-150, July.
    69. Zijun Wang, 2013. "Do the Investment and Return-on-Equity Factors Proxy for Economic Risks?," Financial Management, Financial Management Association International, vol. 42(1), pages 183-209, March.
    70. Fama, Eugene F. & French, Kenneth R., 2006. "Profitability, investment and average returns," Journal of Financial Economics, Elsevier, vol. 82(3), pages 491-518, December.
    71. Prombutr, Wikrom & Phengpis, Chanwit & Zhang, Ying, 2012. "What explains the investment growth anomaly?," Journal of Banking & Finance, Elsevier, vol. 36(9), pages 2532-2542.
    72. Christensen, B. J. & Prabhala, N. R., 1998. "The relation between implied and realized volatility," Journal of Financial Economics, Elsevier, vol. 50(2), pages 125-150, November.
    73. Murray Carlson & Adlai Fisher & Ron Giammarino, 2006. "Corporate Investment and Asset Price Dynamics: Implications for SEO Event Studies and Long‐Run Performance," Journal of Finance, American Finance Association, vol. 61(3), pages 1009-1034, June.
    74. Titman, Sheridan & John Wei, K. C. & Xie, Feixue, 2013. "Market Development and the Asset Growth Effect: International Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 48(5), pages 1405-1432, October.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Ehab Yamani & David Rakowski, 2018. "Cash Flow and Discount Rate Risk in the Investment Effect: A Downside Risk Approach," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 8(03), pages 1-40, September.
    2. Li, Yuming, 2018. "Investment and profitability versus value and momentum: The price of residual risk," Journal of Empirical Finance, Elsevier, vol. 46(C), pages 1-10.
    3. Licheng Sun & Liang Meng & Mohammad Najand, 2017. "The Role of U.S. Market on International Risk-Return Tradeoff Relations," The Financial Review, Eastern Finance Association, vol. 52(3), pages 499-526, August.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Lu Zhang, 2017. "The Investment CAPM," European Financial Management, European Financial Management Association, vol. 23(4), pages 545-603, September.
    2. Su, Xuan-Qi, 2016. "Does systematic distress risk drive the investment growth anomaly?," The Quarterly Review of Economics and Finance, Elsevier, vol. 61(C), pages 240-248.
    3. Stefan Nagel, 2013. "Empirical Cross-Sectional Asset Pricing," Annual Review of Financial Economics, Annual Reviews, vol. 5(1), pages 167-199, November.
    4. Guo, Hui & Savickas, Robert & Wang, Zijun & Yang, Jian, 2009. "Is the Value Premium a Proxy for Time-Varying Investment Opportunities? Some Time-Series Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(1), pages 133-154, February.
    5. Calvet, Laurent E. & Betermier, Sebastien & Jo, Evan, 2019. "A Supply and Demand Approach to Equity Pricing," CEPR Discussion Papers 13974, C.E.P.R. Discussion Papers.
    6. Amit Goyal, 2012. "Empirical cross-sectional asset pricing: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(1), pages 3-38, March.
    7. Maio, Paulo & Santa-Clara, Pedro, 2012. "Multifactor models and their consistency with the ICAPM," Journal of Financial Economics, Elsevier, vol. 106(3), pages 586-613.
    8. Wang, Zijun & Khan, M. Moosa, 2017. "Market states and the risk-return tradeoff," The Quarterly Review of Economics and Finance, Elsevier, vol. 65(C), pages 314-327.
    9. Cooper, Ilan & Priestley, Richard, 2011. "Real investment and risk dynamics," Journal of Financial Economics, Elsevier, vol. 101(1), pages 182-205, July.
    10. Kewei Hou & Chen Xue & Lu Zhang, 2012. "Digesting Anomalies: An Investment Approach," NBER Working Papers 18435, National Bureau of Economic Research, Inc.
    11. Ehab Yamani & David Rakowski, 2018. "Cash Flow and Discount Rate Risk in the Investment Effect: A Downside Risk Approach," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 8(03), pages 1-40, September.
    12. Jegadeesh, Narasimhan & Noh, Joonki & Pukthuanthong, Kuntara & Roll, Richard & Wang, Junbo, 2019. "Empirical tests of asset pricing models with individual assets: Resolving the errors-in-variables bias in risk premium estimation," Journal of Financial Economics, Elsevier, vol. 133(2), pages 273-298.
    13. Kang, Hankil & Kang, Jangkoo & Lee, Changjun, 2013. "Do the production-based factors capture the time-varying patterns in stock returns?," Emerging Markets Review, Elsevier, vol. 15(C), pages 122-135.
    14. Da, Zhi & Guo, Re-Jin & Jagannathan, Ravi, 2012. "CAPM for estimating the cost of equity capital: Interpreting the empirical evidence," Journal of Financial Economics, Elsevier, vol. 103(1), pages 204-220.
    15. Ray Ball & Gil Sadka & Ayung Tseng, 2022. "Using accounting earnings and aggregate economic indicators to estimate firm-level systematic risk," Review of Accounting Studies, Springer, vol. 27(2), pages 607-646, June.
    16. Lewellen, Jonathan, 2010. "Accounting anomalies and fundamental analysis: An alternative view," Journal of Accounting and Economics, Elsevier, vol. 50(2-3), pages 455-466, December.
    17. Huang, Yuan & Lam, F.Y. Eric C. & Wei, K.C. John, 2014. "The q-theory explanation for the external financing effect: New evidence," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 69-81.
    18. Xiaoji Lin & Lu Zhang, 2011. "Covariances versus Characteristics in General Equilibrium," NBER Working Papers 17285, National Bureau of Economic Research, Inc.
    19. Ilan Cooper & Paulo Maio, 2019. "Asset Growth, Profitability, and Investment Opportunities," Management Science, INFORMS, vol. 65(9), pages 3988-4010, September.
    20. Christian Walkshäusl & Sebastian Lobe, 2014. "The Alternative Three†Factor Model: An Alternative beyond US Markets?," European Financial Management, European Financial Management Association, vol. 20(1), pages 33-70, January.

    More about this item

    Keywords

    Investment factor; ICAPM; Investment opportunities; GARCH; MIDAS;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:44:y:2014:i:c:p:219-232. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jbf .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.