Working Paper: NBER ID: w16747
Authors: Laura Xiaolei Liu; Lu Zhang
Abstract: Optimal investment of firms implies that expected stock returns are tied with the expected marginal benefit of investment divided by the marginal cost of investment. Winners have higher expected growth and expected marginal productivity (two major components of the marginal benefit of investment), and earn higher expected stock returns than losers. The investment model succeeds in capturing average momentum profits, reversal of momentum in long horizons, as well as the interaction of momentum with market capitalization, firm age, trading volume, and stock return volatility. However, the model fails to reproduce procyclical momentum profits.
Keywords: Momentum; Investment; Asset Pricing
JEL Codes: G12; G14; G31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher expected growth and expected marginal productivity (O49) | higher expected stock returns (G17) |
| expected marginal benefit of investment divided by the marginal cost of investment (G31) | higher expected stock returns (G17) |
| cross-sectional variation in expected growth (O41) | increase in alpha (C45) |
| expected investment-to-capital growth (E22) | reversal of momentum profits (E32) |
| predicted momentum profits do not significantly differ following up versus down markets (G17) | failure to reproduce procyclical momentum profits (E32) |