Real options models of the firm, capacity overhang, and the cross-section of stock returns

Aretz, Kevin and Pope, Peter F. (2018) Real options models of the firm, capacity overhang, and the cross-section of stock returns. Journal of Finance, 73 (3). 1363 - 1415. ISSN 0022-1082

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Abstract

We use a stochastic frontier model to obtain a stock-level estimate of the difference between a firm's installed production capacity and its optimal capacity. We show that this "capacity overhang" estimate relates significantly negatively to the cross-section of stock returns, even when controlling for popular pricing factors. The negative relation persists among small and large stocks, stocks with more or less reversible investments, and in good and bad economic states. Capacity overhang helps explain momentum and profitability anomalies, but not value and investment anomalies. Our evidence supports real options models of the firm featuring valuable divestment options.

Item Type:	Article
Official URL:	https://onlinelibrary.wiley.com/journal/15406261
Additional Information:	© 2018 The Authors
Divisions:	Accounting
Subjects:	H Social Sciences > HF Commerce > HF5601 Accounting
Date Deposited:	05 Dec 2017 13:50
Last Modified:	11 Dec 2024 21:32
URI:	http://eprints.lse.ac.uk/id/eprint/85963

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