THE INVESTMENT OPPORTUNITY SET AND ITS PROXY VARIABLES

Tim Adam and Vidhan Goyal

Journal of Financial Research, 2008, vol. 31, issue 1, 41-63

Abstract: We use a real options approach to evaluate the performance of several proxy variables for a firm's investment opportunity set. The results show that, on a relative scale, the market‐to‐book assets ratio has the highest information content with respect to investment opportunities. Although both the market‐to‐book equity and the earnings–price ratios are related to investment opportunities, they do not contain information that is not already contained in the market‐to‐book assets ratio. Consistent with this finding, a common factor constructed from several proxy variables does not improve the performance of the market‐to‐book assets ratio.

Date: 2008
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