RFS Advance Access originally published online on September 28, 2007
Review of Financial Studies 2008 21(4):1767-1795; doi:10.1093/rfs/hhm051
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Interpreting the Value Effect Through the Q-Theory: An Empirical Investigation
Rice University
Address correspondence to Yuhang Xing, Rice University, 6100 Main street, Houston, TX 77005, or e-mail: yxing{at}rice.edu
JEL: G12
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Abstract |
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This article interprets the well-known value effect through the implications of standard Q-theory. An investment growth factor, defined as the difference in returns between low-investment stocks and high-investment stocks, contains information similar to the Fama and French (1993) value factor (HML), and can explain the value effect about as well as HML. In the cross-section, portfolios of firms with low investment growth rates (IGRs) or low investment-to-capital ratios have significantly higher average returns than those with high IGRs or high investment-to-capital ratios. The value effect largely disappears after controlling for investment, and the investment effect is robust against controls for the marginal product of capital. These results are consistent with the predictions of a standard Q-theory model with a stochastic discount factor.
This article was previously entitled "Firm Investments and Expected Equity Returns." The author thanks Andrew Ang, Geert Bekaert, John Donaldson, and Maria Vassalou and seminar participants at Columbia University, Yale University, University of Colorado, Ohio State University,University of California-Irvine, Washington University, University of British Columbia, and Rice University. The author is especially grateful for the thoughtful and thorough comments of the two referees, which greatly improved the paper.