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Investment and the Cross-Section of Equity Returns

Author

Listed:
  • Berardino Palazzo

    (Boston University, School of management)

  • Gian Luca Clementi

    (Stern School of Business)

Abstract
Since the seminal contribution of Berk, Green, and Naik (Journal of Finance, 1999), we have witnessed a growing interest in rationalizing the observed cross-sectional relation between investment and stock returns. Unfortunately, however, the extant literature falls short of ensuring that the models in use are consistent with stylized facts on firm dynamics long established by the empirical I&O literature. The contribution of this paper is to study the cross-section of returns in a standard neoclassical model of firm dynamics parameterized to match those stylized facts. We start by characterizing the investment process among public firms in the United States, along the lines of what accomplished by Cooper & Haltiwanger (ReStud, 2006) for the universe of manufacturing establishments. Then, we write down a model of industry dynamics along the lines of Hopenhayn (Econometrica, 1992) augmented with aggregate shocks, capital accumulation, and a time-varying discount factor. The parameters are calibrated to ensure that the simulated investment behavior is consistent with our empirical findings. The goal is to quantify the role of investment as a determinant (and predictor) of the cross-sectoral variation in returns.

Suggested Citation

  • Berardino Palazzo & Gian Luca Clementi, 2012. "Investment and the Cross-Section of Equity Returns," 2012 Meeting Papers 543, Society for Economic Dynamics.
    • Handle: RePEc:red:sed012:543
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    References listed on IDEAS

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    3. Mathias Lé & Frédéric Vinas, 2020. "The Financing of Investment: Firm Size, Asset Tangibility and the Size of Investment," Working papers 777, Banque de France.
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    5. Muhammad Nazmul Khan, 2022. "Estimating empirical marginal adjustment cost function: a power series approach," Empirical Economics, Springer, vol. 63(6), pages 3185-3210, December.
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    More about this item

    JEL classification:

    • D24 - Microeconomics - - Production and Organizations - - - Production; Cost; Capital; Capital, Total Factor, and Multifactor Productivity; Capacity
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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