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Investment-Based Expected Stock Returns

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  • Laura Xiaolei Liu
  • Toni M. Whited
  • Lu Zhang

Abstract

We derive and test q-theory implications for cross-sectional stock returns. Under constant returns to scale, stock returns equal levered investment returns, which are tied directly to firm characteristics. When we use generalized method of moments to match average levered investment returns to average observed stock returns, the model captures the average stock returns of portfolios sorted by earnings surprises, book-to-market equity, and capital investment. When we try to match expected returns and return variances simultaneously, the variances predicted in the model are largely comparable to those observed in the data. However, the resulting expected return errors are large. (c) 2009 by The University of Chicago. All rights reserved.

Suggested Citation

  • Laura Xiaolei Liu & Toni M. Whited & Lu Zhang, 2009. "Investment-Based Expected Stock Returns," Journal of Political Economy, University of Chicago Press, vol. 117(6), pages 1105-1139, December.
    • Handle: RePEc:ucp:jpolec:v:117:y:2009:i:6:p:1105-1139
    DOI: 10.1086/649760
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    References listed on IDEAS

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