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Expected Investment Growth and the Cross Section of Stock Returns Analysis

Last Updated on 10 February, 2024 by Rejaul Karim

The paper “Expected Investment Growth and the Cross Section of Stock Returns” by Jun Li from the University of Texas at Dallas and Huijun Wang from Auburn University delves into a novel measure of corporate investment plans: the expected investment growth (EIG).

The abstract introduces a compelling observation – firms with high EIG exhibit substantial future investment growth and earn notably higher returns than their low EIG counterparts, a phenomenon that defies conventional factor models.

The study also delves into the nexus of EIG with distress risk, particularly emphasizing its short-term influence. Intriguingly, the paper navigates the juxtaposition of traditional distress risk measures across different time horizons, offering an insightful analysis of the complexities associated with cross-sectional stock returns.

Overall, this research sets the stage for a thought-provoking exploration of the interplay between expected investment growth and stock returns within the financial landscape.

Abstract Of Paper

We propose a measure of corporate investment plans, namely, the expected investment growth (EIG). We document a robust finding that firms with high EIG have larger future investment growth and earn significantly higher returns than firms with low EIG, which cannot be fully explained by leading factor models. Further analyses reveal that EIG is closely related to distress risk, especially at short-run horizons up to one year. Detailed comparisons with traditional distress risk measures highlight the distinction between the short-run and long-run horizons in reconciling the opposite signs of distress premium documented in the literature.

Original paper – Download PDF

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Author

Jun Li
University of Texas at Dallas

Huijun Wang
Auburn University

Conclusion

The study “Expected Investment Growth and the Cross Section of Stock Returns” by Jun Li and Huijun Wang presents a compelling investigation into the evolving dynamics of corporate investment plans and its association with stock returns.

The identification of firms with high expected investment growth (EIG) as demonstrating superior future investment growth and higher returns compared to their low EIG counterparts, defying conventional factor models, stands as a robust finding.

The paper’s in-depth analysis also highlights the interrelationship between EIG and distress risk, particularly emphasizing its pivotal role in short-run horizons up to one year. The paper’s comparison of traditional distress risk measures across varying time horizons offers valuable insights for reconciling the dichotomous distress premiums documented in existing literature.

Overall, this study provides a nuanced understanding of the complexities within cross-sectional stock returns and lays a foundation for further exploration of this intricate financial landscape.

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FAQ

What is the focus of the paper “Expected Investment Growth and the Cross Section of Stock Returns”?

The focus of the paper is to introduce and explore a novel measure of corporate investment plans called expected investment growth (EIG). The authors aim to investigate the relationship between EIG and stock returns in the cross-section of firms. The paper explores the implications of high and low EIG on future investment growth and stock returns, challenging conventional factor models.

What is the key finding of the paper regarding firms with high EIG?

The key finding is that firms with high expected investment growth (EIG) exhibit larger future investment growth and earn significantly higher returns compared to firms with low EIG. This finding persists even after accounting for leading factor models, suggesting that EIG provides unique information about future firm performance and stock returns.

How does EIG relate to distress risk, and what is emphasized regarding its short-term influence?

The paper highlights a close relationship between expected investment growth (EIG) and distress risk, particularly emphasizing its influence in the short run, up to one year. The short-term influence of EIG on distress risk suggests that EIG is a valuable indicator for understanding and predicting the short-term dynamics of distress in firms.

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