Premium
Asset Pricing Implications of Nonconvex Adjustment Costs and Irreversibility of Investment
Author(s) -
COOPER ILAN
Publication year - 2006
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2006.00832.x
Subject(s) - value premium , economics , capital asset pricing model , investment (military) , systematic risk , value (mathematics) , cost of capital , risk premium , equity (law) , consumption based capital asset pricing model , monetary economics , capital (architecture) , microeconomics , financial economics , profit (economics) , archaeology , machine learning , politics , political science , computer science , law , history
This paper derives a real options model that accounts for the value premium. If real investment is largely irreversible, the book value of assets of a distressed firm is high relative to its market value because it has idle physical capital. The firm's excess installed capital capacity enables it to fully benefit from positive aggregate shocks without undertaking costly investment. Thus, returns to equity holders of a high book‐to‐market firm are sensitive to aggregate conditions and its systematic risk is high. Simulations indicate that the model goes a long way toward accounting for the observed value premium.