Working Papers
Abstract: I study the asset pricing implications of investment and disinvestment options with a production-based model featuring costly reversibility. Investment options are contingent claims on assets in place so that they are riskier and earn higher expected returns. Disinvestment options with costly reversibility reduce exposure to aggregate risks amid deteriorating business conditions and lower expected returns on a firm. The inextricable link between investment options and disinvestment options explains the coexistence of the profitability premium and the value premium while retains a positive relation between profitability and market valuation ratios. My model also generates a procyclical profitability premium and a countercyclical value premium.
Presented at Midwest Finance Association meeting and Macro-Finance Society Workshop.
Abstract: We investigate the joint asset pricing effects of variable costs and fixed costs in a firm's production process. While the latter such as SG&A expenses create an operating leverage effect, the variable costs allow firms to hedge against aggregate profitability shocks. Taking into account both types of production costs explains the empirical patterns in the cross-section asset returns in portfolios sorted by the gross profitability and operating leverage. Our model reconciles the seemingly contradictory phenomena that higher productivity firms earn lower returns (Imrohoroglu and Tuzel (2014)), whereas more profitable, often more productive, firms earn higher returns (Novy-Marx (2013)). It also offers a novel explanation for the negative idiosyncratic volatility premium (Ang, Hodrick, Xing, and Zhang (2006)) based on production costs.
Presented at Australian National University, Chinese University of Hong Kong, Baylor University, Ohio State University, University of Cincinnati, European Finance Association meeting, North Finance Association meeting, Midwest Finance Association meeting, the PKU/PHBS Sargent Institute Macro-Finance Workshop, the Summer Institute of Finance, and the 9th annual workshop on investment and production-based asset pricing.