The y-Theory of Investment

Thomas Philippon ()

No 204, 2007 Meeting Papers from Society for Economic Dynamics

Abstract: I propose a new implementation of the q-theory of investment using corporate bond yields instead of equity prices. In q-theory, the optimal investment rate is a function of risk-adjusted discount rates and of future marginal profitability. Corporate bond prices also depend on these variables. I show that, when aggregate shocks are small, aggregate q is a linear combination of risk free rates and average yields on risky corporate debt. The yield-theory of investment, unlike its equity-based counter part, is empirically successful: it can account for more than half of the volatility of investment in post-war US data, it drives out cash flows from the investment equation, and it delivers sensible estimates for the parameters of the adjustment cost function.

Date: 2007
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed007:204

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