Equity Capital: A Puzzle?
41 Pages Posted: 8 Nov 2006
Abstract
In almost any equilibrium model, shifts in sectoral wealth have direct implications for asset returns so as to induce investors to hold more or less of their wealth in the sector. For an expanding sector, these inducements can be in the form of higher mean or lower volatility of asset. In this paper, we document that shifts in sectoral financial wealth have virtually no bearing on the subsequent mean and volatility of sectoral returns. About 90% of the wealth share fluctuations are due to movements in net payouts and 10% due to changes in expected returns. Our evidence is that sectoral wealth and asset returns show no relation|this leads to the equity capital puzzle. Why then are investors willing to hold more (less) wealth share of an expanding (contracting) sector?
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