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Optimal Investment, Growth Options, and Security Returns

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  • Jonathan Berk
  • Richard C. Green
  • Vasant Naik

Abstract

As a consequence of optimal investment choices, firms' 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.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 6627.

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Date of creation: Jun 1998
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Publication status: published as Journal of Finance, Vol. 54 (1999): 1553-1608.
Handle: RePEc:nbr:nberwo:6627

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