IDEAS home Printed from https://ideas.repec.org/a/eee/jfinec/v101y2011i1p182-205.html
   My bibliography  Save this article

Real investment and risk dynamics

Author

Listed:
  • Cooper, Ilan
  • Priestley, Richard

Abstract

We ask to what extent the negative relation between investment and average stock returns is driven by risk. We show that: (i) the average return spread between low and high asset growth and investment portfolios is largely accounted for by their spread in systematic risk, as measured by the loadings on the Chen, Roll, and Ross (1986) factors; (ii) as predicted by q-theory and real options models, systematic risk falls during large investment periods; (iii) the returns of factors formed on the investment-to-assets, asset growth, and investment growth all forecast aggregate economic activities. Our evidence suggests that risk plays an important role in explaining the investment-return relation.

Suggested Citation

  • Cooper, Ilan & Priestley, Richard, 2011. "Real investment and risk dynamics," Journal of Financial Economics, Elsevier, vol. 101(1), pages 182-205, July.
  • Handle: RePEc:eee:jfinec:v:101:y:2011:i:1:p:182-205
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0304405X11000353
    Download Restriction: Full text for ScienceDirect subscribers only

    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. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    2. Plosser, Charles I, 1989. "Understanding Real Business Cycles," Journal of Economic Perspectives, American Economic Association, vol. 3(3), pages 51-77, Summer.
    3. Jonathan B. Berk, 2004. "Valuation and Return Dynamics of New Ventures," Review of Financial Studies, Society for Financial Studies, vol. 17(1), pages 1-35.
    4. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    5. 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.
    6. Lettau, Martin & Ludvigson, Sydney, 2002. "Time-varying risk premia and the cost of capital: An alternative implication of the Q theory of investment," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 31-66, January.
    7. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
    8. 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.
    9. Ravi Bansal & Robert F. Dittmar & Christian T. Lundblad, 2005. "Consumption, Dividends, and the Cross Section of Equity Returns," Journal of Finance, American Finance Association, vol. 60(4), pages 1639-1672, August.
    10. Christopher W. Anderson & Luis Garcia-Feijão, 2006. "Empirical Evidence on Capital Investment, Growth Options, and Security Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 171-194, February.
    11. Lu Zhang, 2005. "The Value Premium," Journal of Finance, American Finance Association, vol. 60(1), pages 67-103, February.
    12. Owen A. Lamont & Jeremy C. Stein, 2006. "Investor Sentiment and Corporate Finance: Micro and Macro," American Economic Review, American Economic Association, vol. 96(2), pages 147-151, May.
    13. Arturo Estrella, 2005. "Why Does the Yield Curve Predict Output and Inflation?," Economic Journal, Royal Economic Society, vol. 115(505), pages 722-744, July.
    14. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March.
    15. 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.
    16. Andrew Ang & Robert J. Hodrick & Yuhang Xing & Xiaoyan Zhang, 2006. "The Cross-Section of Volatility and Expected Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 259-299, February.
    17. Pindyck, Robert S, 1988. "Irreversible Investment, Capacity Choice, and the Value of the Firm," American Economic Review, American Economic Association, vol. 78(5), pages 969-985, December.
    18. Ferson, Wayne & Siegel, Andrew F. & Xu, Pisun (Tracy), 2006. "Mimicking Portfolios with Conditioning Information," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 41(03), pages 607-635, September.
    19. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    20. Grinblatt, Mark & Titman, Sheridan D, 1989. "Mutual Fund Performance: An Analysis of Quarterly Portfolio Holdings," The Journal of Business, University of Chicago Press, vol. 62(3), pages 393-416, July.
    21. Vassalou, Maria, 2003. "News related to future GDP growth as a risk factor in equity returns," Journal of Financial Economics, Elsevier, vol. 68(1), pages 47-73, April.
    22. 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.
    23. Li, Dongmei & Zhang, Lu, 2010. "Does q-theory with investment frictions explain anomalies in the cross section of returns?," Journal of Financial Economics, Elsevier, vol. 98(2), pages 297-314, November.
    24. 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.
    25. 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(04), pages 677-700, December.
    26. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, Oxford University Press, vol. 101(4), pages 707-727.
    27. Estrella, Arturo & Hardouvelis, Gikas A, 1991. " The Term Structure as a Predictor of Real Economic Activity," Journal of Finance, American Finance Association, vol. 46(2), pages 555-576, June.
    28. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-1370, November.
    29. Ferson, Wayne E. & Harvey, Campbell R., 1994. "Sources of risk and expected returns in global equity markets," Journal of Banking & Finance, Elsevier, vol. 18(4), pages 775-803, September.
    30. Owen A. Lamont, 2000. "Investment Plans and Stock Returns," Journal of Finance, American Finance Association, vol. 55(6), pages 2719-2745, December.
    31. Newey, Whitney & West, Kenneth, 2014. "A simple, positive semi-definite, heteroscedasticity and autocorrelation consistent covariance matrix," Applied Econometrics, Publishing House "SINERGIA PRESS", vol. 33(1), pages 125-132.
    32. 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.
    33. 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.
    34. Fama, Eugene F, 1981. "Stock Returns, Real Activity, Inflation, and Money," American Economic Review, American Economic Association, vol. 71(4), pages 545-565, September.
    35. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
    36. Lawrence J. Christiano & Michele Boldrin & Jonas D. M. Fisher, 2001. "Habit Persistence, Asset Returns, and the Business Cycle," American Economic Review, American Economic Association, vol. 91(1), pages 149-166, March.
    37. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    38. 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.
    39. Lehmann, Bruce N. & Modest, David M., 1988. "The empirical foundations of the arbitrage pricing theory," Journal of Financial Economics, Elsevier, vol. 21(2), pages 213-254, September.
    40. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    41. Douglas T. Breeden & Michael R Gibbons & Robert H. Litzenberger, "undated". "Empirical Tests of the Consumption-Oriented CAPM," Rodney L. White Center for Financial Research Working Papers 7-89, Wharton School Rodney L. White Center for Financial Research.
    42. 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.
    43. James H. Stock & Mark W. Watson, 1989. "New Indexes of Coincident and Leading Economic Indicators," NBER Chapters,in: NBER Macroeconomics Annual 1989, Volume 4, pages 351-409 National Bureau of Economic Research, Inc.
    44. Chen, Nai-Fu, 1991. " Financial Investment Opportunities and the Macroeconomy," Journal of Finance, American Finance Association, vol. 46(2), pages 529-554, June.
    45. 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.
    46. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
    47. 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.
    48. Liew, Jimmy & Vassalou, Maria, 2000. "Can book-to-market, size and momentum be risk factors that predict economic growth?," Journal of Financial Economics, Elsevier, vol. 57(2), pages 221-245, August.
    49. Ilan Cooper, 2006. "Asset Pricing Implications of Nonconvex Adjustment Costs and Irreversibility of Investment," Journal of Finance, American Finance Association, vol. 61(1), pages 139-170, February.
    50. Ferson, Wayne E & Harvey, Campbell R, 1993. "The Risk and Predictability of International Equity Returns," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 527-566.
    51. Laura Xiaolei Liu & Lu Zhang, 2008. "Momentum Profits, Factor Pricing, and Macroeconomic Risk," Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2417-2448, November.
    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. repec:eee:ecofin:v:42:y:2017:i:c:p:473-486 is not listed on IDEAS
    2. Galil, Koresh & Shapir, Offer Moshe & Amiram, Dan & Ben-Zion, Uri, 2014. "The determinants of CDS spreads," Journal of Banking & Finance, Elsevier, vol. 41(C), pages 271-282.
    3. Cooper, Ilan & Priestley, Richard, 2016. "The expected returns and valuations of private and public firms," Journal of Financial Economics, Elsevier, vol. 120(1), pages 41-57.
    4. Brennan, Michael J. & Kraft, Holger, 2015. "Leaning against the wind: Debt financing in the face of adversity," SAFE Working Paper Series 119, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    5. 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.
    6. Lu Zhang, 2017. "The Investment CAPM," NBER Working Papers 23226, National Bureau of Economic Research, Inc.
    7. 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.
    8. Wang, Yifeng & Liu, Cheyuan & Lee, Jen-Sin & Wang, Yanming, 2015. "The relation between asset growth and the cross-section of stock returns: Evidence from the Chinese stock market," Economic Modelling, Elsevier, vol. 44(C), pages 59-67.
    9. Kroencke, Tim A. & Schindler, Felix & Sebastian, Steffen & Theissen, Erik, 2013. "GDP mimicking portfolios and the cross-section of stock returns," ZEW Discussion Papers 13-026, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    10. repec:eee:finmar:v:36:y:2017:i:c:p:76-90 is not listed on IDEAS
    11. Dongmei Li & Lu Zhang, 2008. "Costly External Finance: Implications for Capital Markets Anomalies," NBER Working Papers 14342, National Bureau of Economic Research, Inc.
    12. Frederico Belo & Chen Xue & Lu Zhang, 2013. "A Supply Approach to Valuation," Review of Financial Studies, Society for Financial Studies, vol. 26(12), pages 3029-3067.

    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:jfinec:v:101:y:2011:i:1:p:182-205. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/inca/505576 .

    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 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.

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

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.