INVESTMENT UNCERTAINTY AND STOCK RETURNS

Chyi-Lun Chiou

The International Journal of Business and Finance Research, 2008, vol. 2, issue 1, 61-71

Abstract: This paper theoretically investigates the effect of uncertainty about future investment on expected stock returns. Based on a real options framework, we incorporate the learning-by-doing effect to analyze the irreversible investment problem. In our investment decision framework, the timing of expansion is endogenous and results from a value-maximizing decision. In addition, there are two important implications of our framework. First, we show that an increase in the relative valuation ratio, as measured by the book-to-market ratio, raises average stock returns. This positive relationship helps to explain the value premium. Second, we investigate how uncertainty about investment affects expected stock returns. Based on the closed-form solution in our framework, we suggest that less uncertainty about investment induces lower expected stock returns.

JEL-codes: D81 G31 (search for similar items in EconPapers)
Date: 2008
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Persistent link: https://EconPapers.repec.org/RePEc:ibf:ijbfre:v:2:y:2008:i:1:p:61-71

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