Source: www.som.yale.edu
Topic: Stock Investment
Sort Desciption: ative contemporaneous correlation of investment and stock returns. To di- ..... returns in column 6 shows that the reason that investment and stock re- ...
Content Inside: Investment Plans and Stock Returns OWEN A. LAMONT* ABSTRACT When the discount rate falls, investment should rise. Thus with time-varying dis- count rates and instantly changing investment, investment should positively co- vary with current stock returns and negatively covary with future stock returns. Aggregate nonresidential U.S. investment contradicts both these implications, prob- ably because of investment lags. Investment plans, however, satisfy both implica- tions. These investment plans, from a U.S. government survey of firms, are highly informative measures of expected investment and explain more than three- quarters of the variation in real annual aggregate investment growth. Plans have substantial forecasting power for excess stock returns, showing that time-varying risk premia affect investment. A BASIC IDEA IN ECONOMICS and finance is that when the discount rate falls, investment should rise. If discount rates move over time and investment instantly adjusts, then the idea has two implications. First, investment and stock returns should positively covary over time. This positive contempora- neous covariation occurs because when discount rates fall, firms increase investmentsince the hurdle rate on investment falls! and stock prices rise since the discounted sum of future cash flows rises!. Second, investment and future stock returns should negatively covary over time. This negative covariation occurs because when discount rates are low, investment today is high and future expected returns are low. Post-war annual aggregate U.S. data on stock returns and nonresidential investment growth contradict these implications. Investment and stock re- turns have a significant negative contemporaneous covariation, and invest- ment and future stock returns have a covariation that is not statistically different from zero. The significant negative contemporaneous covariation is particularly puzzling since it seems to suggest that firms perversely ...
