Working Paper: NBER ID: w14342
Authors: Dongmei Li; Lu Zhang
Abstract: In a frictionless world, investment is perfectly elastic to changes in the discount rate. With financial frictions, investment is less elastic, meaning that a given magnitude of change in investment is associated with a higher magnitude of change in the discount rate. Equivalently, investment is a more powerful predictor of future stock returns. Consistent with this prediction, we document that the asset growth, external finance, and accrual anomalies in the cross-section of stock returns are much stronger in financially more constrained firms than in financially less constrained firms. Further tests show that this effect of financial constraints is distinct from the effect of financial distress and the effect of limits of arbitrage on the magnitude of the anomalies.
Keywords: No keywords provided
JEL Codes: G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Financial constraints (D10) | Asset growth anomalies (G19) |
| Financial constraints (D10) | External finance anomalies (G39) |
| Financial constraints (D10) | Accrual anomalies (G14) |
| Financial constraints (D10) | Average return for high-minus-low asset growth portfolio (G11) |
| Financial constraints (D10) | CAPM alpha for high-minus-low asset growth portfolio (G11) |
| Financial constraints (D10) | Fama-French alpha for high-minus-low asset growth portfolio (G11) |
| Financial constraints (D10) | Distinct from financial distress (G33) |