Firm Migration and Stock Returns
AbstractThis paper studies the asset pricing implications of a general equilibrium model in which real investment is reversible at a cost. Firms face higher costs in contracting than in expanding their capital stock and decide to invest when their productive capital is scarce relative to the overall capital of the economy. Positive shocks to the production process of the firm increase the size of the firm and reduce the value of growth options. As a result, the firm is burdened with more unproductive capital and its value lowers with respect to the accumulated capital. The optimal consumption policy alters the optimal allocation of resources and affects firm's value, generating mean-reverting dynamics for the M/B ratios. The model (1) captures convergence of price-to-book ratios - negative for growth stocks and positive for value stocks - (firm migration), (2) generates deviations from the classic CAPM in line with the cross-sectional variation in expected stock returns and (3) generates a non-monotone relationship between Tobin's q and conditional volatility consistent with the empirical evidence.
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Bibliographic InfoPaper provided by IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University in its series Working Papers with number 394.
Date of creation: 2011
Date of revision:
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Other versions of this item:
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- D92 - Microeconomics - - Intertemporal Choice - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
- D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
- D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
- D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
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