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Optimal Investment, Growth Options, and Security Returns

Jonathan Berk, Richard Green and Vasant Naik

No 6627, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: As a consequence of optimal investment choices, firms' assets and growth options change in predictable ways. Using a dynamic model, we show that this imparts predictability to changes in a firm's systematic risk, and its expected return. Simulations show that the model simultaneously reproduces: (i) the time series relation between the book-to-market ratio and asset returns, (ii) the cross-sectional relation between book to market, market value and return, (iii) contrarian effects at short horizons, (iv) momentum effects at longer horizons, and (v) the inverse relation between interest rates and the market risk premium.

JEL-codes: G12 G13 (search for similar items in EconPapers)
Date: 1998-06
New Economics Papers: this item is included in nep-ifn
Note: AP
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Published as Journal of Finance, Vol. 54 (1999): 1553-1608.

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