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The Dynamics of Tobin’s Q

In this paper I propose a general-equilibrium model with proportional adjustment costs and industry-specific capital to study the firm migration phenomenon across market-to-book ratio. In my model, investors’ desire to diversify their portfolios and investment frictions generate a mean-reverting dynamics of Tobin’s q consistent with the probabilities of migration found in the data, and a nonlinear pattern in the conditional volatility of Tobin’s q. In addition, since firms’ market-to-book ratios are function of the state of the economy and contain information about stock returns, stock prices inherit these properties, yielding asset-pricing implications in line with the empirical evidence, namely the value premium and a non-monotone relationship between the volatility of stock returns and the Tobin’s q.

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Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 286.

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Date of creation: 31 May 2011
Date of revision: 12 Oct 2015
Handle: RePEc:sef:csefwp:286
Note: A previous version of the paper was titled "Firm Migration and Stock Returns".
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