Do Investment-Based Models Explain Equity Returns? Evidence from Euler Equations

Stefanos Delikouras and Robert F Dittmar

The Review of Financial Studies, 2022, vol. 35, issue 8, 3823-3866

Abstract: We investigate the empirical implications of the investment-based model of asset pricing for the Hansen-Jagannathan and Kozak-Nagel-Santosh discount factors in the linear span of equity returns. We find that the stochastic discount factors satisfying the Euler equation for equity returns cannot satisfy the Euler equation for investment returns because returns on corporate investment covary inversely with the sources of equity risk relative to returns on equity. As a result, the model fails to replicate the level of the risk premium. Our results suggest that joint restrictions on the optimality of investment and consumption pose stringent conditions for candidate production models.

JEL-codes: D25 E22 E44 G12 G31 (search for similar items in EconPapers)
Date: 2022
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