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Limits‐to‐arbitrage, investment frictions, and the investment effect: New evidence
Author(s) -
Lam F. Y. Eric C.,
Li Ya,
Prombutr Wikrom,
Wei K. C. John
Publication year - 2020
Publication title -
european financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.311
H-Index - 64
eISSN - 1468-036X
pISSN - 1354-7798
DOI - 10.1111/eufm.12216
Subject(s) - economics , arbitrage , volatility (finance) , financial economics , cash flow , profitability index , limits to arbitrage , investment (military) , investment theory , capital asset pricing model , econometrics , investment strategy , monetary economics , microeconomics , finance , market liquidity , politics , political science , law
This study comprehensively reexamines the debate over behavioral and rational explanations for the investment effect in an updated sample. We closely follow the previous literature and provide several differences. Our tests include five prominent measures of corporate investment and corporate profitability in q ‐theory and recent investment‐based asset pricing models. Both classical and Bayesian inferences show that limits‐to‐arbitrage tend to be supported by more evidence than investment frictions for all investment measures. When idiosyncratic volatility and cash flow volatility are used in measuring investment frictions, the inference is more favorable for the rational explanation.