Discussion of
Investment and the Cross-Section of Equity
Returns
by Clementi and Palazzo
Xiaoji Lin
Ohio State University
AFA
January 4, 2015
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Context: Value premium in investment-based models
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Operating leverage and costly (ir)reversibility of investment
I
I
Investment-speci…c technology shocks
I
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Belo, Lin and Bazdresch ’14, Favilukis and Lin ’14
Financial frictions
I
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Papanikolaou ’11, Papanikolaou and Kogan ’14, Li ’14
Labor market frictions
I
I
Carlson, Fisher and Giammarino ’04, Zhang ’05, Cooper ’06, Liu,
Whited and Zhang ’09, Imrohoroglu and Tuzel ’14
Gomes and Schmid ’10, Belo, Lin and Yang ’14
This paper: questions the quantitative e¤ect of the operating
leverage channel
2 / 14
Context: Value premium in investment-based models
I
Operating leverage and costly (ir)reversibility of investment
I
I
Investment-speci…c technology shocks
I
I
Belo, Lin and Bazdresch ’14, Favilukis and Lin ’14
Financial frictions
I
I
Papanikolaou ’11, Papanikolaou and Kogan ’14, Li ’14
Labor market frictions
I
I
Carlson, Fisher and Giammarino ’04, Zhang ’05, Cooper ’06, Liu,
Whited and Zhang ’09, Imrohoroglu and Tuzel ’14
Gomes and Schmid ’10, Belo, Lin and Yang ’14
This paper: questions the quantitative e¤ect of the operating
leverage channel
2 / 14
Summary of the …ndings
A standard investment-based model as in Zhang ’05
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calibrates adj. costs to match …rm-level investment dynamics
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generates a negative value premium
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produces a positive correlation between size and BM
3 / 14
Model calibration
Technology
dividend:
dt = pt est +zt kt0:6
it
:00005ktfit 6=0g
aggregate:
zt+1 = :95zt + :007"z;t+1
idiosyncratic:
st+1 = :90st + :009"s;t+1
:02
i2t
kt
:00385
SDF
log Mt+1 = log :9965
t
= (3:15
t "z;t+1
1
2
2
t
:0072
15:75zt )
4 / 14
Results
moments
book-to-market
…rm-level std i/k
value premium
data
0.757
0.089
1.883
model
0.782
0.087
-0.003
5 / 14
Outline of my discussion
1. Calibration of idiosyncratic volatility
2. Pro…t volatility and wage rigidity as a way of generating operating
leverage
3. Asset pricing tests in this class of models
4. Real in‡exibility and/or …nancial in‡exibility
5. Partial equilibrium vs. general equilibrium
6 / 14
Comment 1: Idiosyncratic volatility
Revisit Zhang ’05
moments
book-to-market
…rm-level std i/k
value premium
data
0.757
0.089
1.883
Zhang’05
0.663
0.065
2.040
Zhang’5 w/t f
0.372
0.065
-0.200
Operating leverage is crucial for a sizable value premium in Zhang ’05.
7 / 14
Comment 1: Idiosyncratic volatility
Calibrated idiosyncratic volatility appears too small
Conditional idiosyncratic volatility 0.009 in the paper vs. 0.17 in Zhang
’05 and 0.08-0.19 in the data (Imrohoroglu and Tuzel ’14)
moments
book-to-market
…rm-level std i/k
cross sectional std i/k
cross sectional std return
value premium
data
0.757
0.089
0.08-0.11
0.12-0.2
1.883
model
0.776
0.082
0.005
0.003
-0.002
high idioVol
0.832
0.087
0.085
0.181
0.862
The XS return volatility: .12-.20 (Campbell et al ’01; Vuolteenaho ’01)
8 / 14
Comment 2: Pro…t volatility
Model implied pro…t volatility appears smaller than the data
pro…t
=
output
f = pt est +zt kt
f
=) std (pro…t) = std (output)
elasticity of pro…t wrt shocks is 1
What happens if we introduce wage rigidity
pro…t
=
where wt
=
output-labor expense = est +zt kt nt
wt
1
+ (1
=) std (pro…t)
wt n t
) target wage
std (output)
elasticity of pro…t wrt shocks bigger than 1
Wage rigidity helps generate sizable value premium w/t relying on …xed
costs (Imrohoroglu and Tuzel ’14 and Favilukis and Lin ’14)
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Comment 3: Asset pricing tests
A: 1964-2012
B: 1927-2012
12
Predicted excess returns(%)
Predicted excess returns(%)
12
10
8
6
4
2
0
0
10
8
6
4
2
2
4
6
8
10
12
0
0
2
4
6
8
10
12
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Comment 3: failure of the CAPM
This class of single factor model can’t produce the failure of the CAPM
6
Predicted excess returns(%)
5
4
3
2
1
0
0
1
2
3
4
5
6
Fix: introduce a second aggregate shock to a¤ect cash ‡ows
11 / 14
Comment 4: Financial in‡exibility and (or) real in‡exibility
13
13
12
12
11
11
10
10
9
9
Mkt+Iss
CAPM
An aggregate …nancial shock (external equity issuance shock) captures the
XS returns across BM portfolios
8
8
7
7
6
6
5
5
4
4
3
4
6
8
Data
10
12
3
4
6
8
Data
10
12
Model insight: the in‡exible substitution between debt and equity is an
important driver of the value premium (Belo et al ’14)
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Comment 5: Partial equilibrium vs. general equilibrium
Interesting questions:
1. Can the mechanisms in partial equilibrium models carry through in
general equilibrium models?
2. With price of risk being endogenous, can general equilibrium models
quantitatively generate value premium?
3. What new predictions can we learn when required to jointly explain
both micro/macro quantities and asset prices?
13 / 14
Conclusion
An interesting paper
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More analysis on the calibration of idiosyncratic volatility
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More analysis on the failure of CAPM
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