Construction, Real Uncertainty, and Stock-Level Investment Anomalies

Forthcoming in the Journal of Financial and Quantitative Analysis

Proceedings of Paris December 2020 Finance Meeting EUROFIDAI - ESSEC

96 Pages Posted: 14 Oct 2020 Last revised: 14 Dec 2023

See all articles by Kevin Aretz

Kevin Aretz

Alliance Manchester Business School

Anastasios Kagkadis

University of Liverpool Management School; Lancaster University - Department of Accounting and Finance

Date Written: December 12, 2023

Abstract

We show that the negative relation between real investments and future stock returns is primarily driven by the subsample of firms building additional capacity. We develop a real options model to rationalize that evidence based on the premise that firms need to learn how to best operate modern capacity vintages, inducing idiosyncratic uncertainty in that capacity’s production costs over the learning period. Conversely, the uncertainty lowers the expected return of firms with newly-built capacity until it is resolved. Further evidence based on profit sensitivities to aggregate conditions; analyst forecast-error volatilities; and high-vs.-low tech industry subsamples supports our uncertainty explanation.

Keywords: Asset pricing; real options; investment anomalies; newly-built capacity; uncertainty.

JEL Classification: G12, G13, G14

Suggested Citation

Aretz, Kevin and Kagkadis, Anastasios, Construction, Real Uncertainty, and Stock-Level Investment Anomalies (December 12, 2023). Forthcoming in the Journal of Financial and Quantitative Analysis, Proceedings of Paris December 2020 Finance Meeting EUROFIDAI - ESSEC, Available at SSRN: https://ssrn.com/abstract=3710507 or http://dx.doi.org/10.2139/ssrn.3710507

Kevin Aretz (Contact Author)

Alliance Manchester Business School ( email )

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Manchester M13 9PL, Lancashire
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HOME PAGE: http://www.kevin-aretz.com

Anastasios Kagkadis

University of Liverpool Management School ( email )

Chatham St
Liverpool, L69 7ZH
United Kingdom

Lancaster University - Department of Accounting and Finance ( email )

The Management School
Lancaster, LA1 4YX
United Kingdom

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