The Great Divorce Between Investment and Profitability: Implications for Asset Pricing
with Mete Kilic and Ben Zhang
Journal of Financial Economics, Revise and resubmit
Using data over the last century, we show that the cross-sectional relation between investment and profitability among U.S. public firms is positive in the first half-century but negative in the recent four decades. The negative fundamental relation explains the high level and the positive correlation of investment and profitability premiums after 1980. In out-of-sample environments including the pre-1980 U.S. stock market where investment and profitability premiums are low and insignificant, the fundamental relation is positive. Given the time-varying investment-profitability correlation, both the in and out-of-sample behaviors of investment and profitability premiums are consistent with the neoclassical investment framework.
Presentations: SFS Cavalcade 2020, MFA 2020, AFA 2021
Predicting Stock Market Returns with an Accounting Factor (** available upon request **)
A predictive factor constructed from aggregate accounting variables robustly predicts month-ahead stock market returns. The factor obtains out-of-sample R-squared statistics of up to 3.05% and the predictive performance is economically large with mean-variance investors being willing to pay an annual fee of up to 6.81% for access to its forecasts. Furthermore, its predictive ability is higher for short-term returns and it is distinct from other predictors in the forecasting literature. Using Google search volume of stock tickers, we demonstrate that the predictive power stems from slow information diffusion due to investor inattention.