Essays On Asset Pricing And Growth Effect

Abstract

This dissertation comprises two essays on growth effects and opportunities experienced by companies and their implications for asset pricing models. In the first essay, I develop and test a model to explain the empirically observed value-growth stock return effect using real options theory. I simulate results from a real options model for two firm types. One type, the "value" firm, has a single growth opportunity. The other type, the "growth" firm, has infinitely repeated growth opportunities. Growth firms: (1) invest sooner, (2) pursue less lumpy investment paths, (3) have lower book-to-market ratios, and (4) generate lower rates of return than value firms. In the second essay, I examine relationships between sustainable growth and subsequent stock returns. Findings indicate that high sustainable growth firms have low default risk, low book-to-market ratio, and low subsequent returns. Cross-sectional tests indicate that sustainable growth subsumes the book-to-market equity ratio.