Limits-to-arbitrage, investment frictions, and the investment effect: New evidence

F. Y.Eric C. Lam, Ya Li, Wikrom Prombutr, K. C.John Wei

Research output: Journal article publicationJournal articleAcademic researchpeer-review

Abstract

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.

Original languageEnglish
Pages (from-to)3-43
Number of pages41
JournalEuropean Financial Management
Volume26
Issue number1
DOIs
Publication statusPublished - Jan 2020

Keywords

  • investment
  • investment frictions
  • limits-to-arbitrage
  • q-theory
  • stock returns

ASJC Scopus subject areas

  • Accounting
  • Economics, Econometrics and Finance(all)

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