Essays in Finance
Date Issued
2008
Date
2008
Author(s)
Chiou, Chyi-Lun
Abstract
In asset pricing, it is well known that stock return and return volatility vary over time. Literature concerns issues abut whether stock returns are predictable and why stock returns are so volatile. Some literature focuses on the relationship between return and risk to examine how assets are priced. In particular, among these literatures systematic risks and idiosyncratic risks provide different explanations to stock returns. Examining the stock return behavior is critical in that asset allocation and hedge strategy are related to this evolution. The primary objective of this thesis is to investigate the stock return predictability base on firm level analysis. This thesis provides two different schemes in discussing this issue, including profitability base and investment base framework. The former states that the valuation of firm is from it profitability, while that latter asserts that the firm’s value is from assts that it holds. We investigate that return-on-equity and investment uncertainty govern the evolution of stock price in an opposite way. Overall, in addition to systematic risks we confirm that it is critical to analyze idiosyncratic risks in valuation. he first part of this dissertation is to examine the stock return predictability through means of volatile volatility. Based on the work of Pástor and Veronesi (2003), we find that the book-to-market ratio and the price evolution, including average stock return and return volatility, are governed by the firms’ profitability. It is straightforward to analyze stock returns by discussing firm’s return-on-equity. Evidence shows that in addition to size and value effects, variation in return-on-equity has the predictability in stock returns. We further demonstrate that this connection may contribute to the equity cash flow perspective and the risk argument of book-to-market ratio.he second part of my dissertation incorporates investment issue in examining stock return behavior. Although recent studies has successfully proved that the value effect results from corporate investment decision, the association between investment uncertainty and stock returns is rarely touched. With irreversibility of investment and learning-by-doing effect, we show that less investment uncertainty follows lower stock returns. If firms face financial constraint in expansion, more investment uncertainty may force them to make suboptimal investment decisions and have more systematic risks.
Subjects
Stock return predictability
Idiosyncratic risks
Profitability
Learning-by-doing
Irreversibility
Variation in return-on-equity
Expected earning volatility
Type
thesis
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