Essays on Production-based Asset Pricing




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This dissertation consists of two essays on production-based asset pricing. The first essay studies the asset pricing implications of investment and disinvestment op- tions with a production-based model featuring costly reversibility. Investment options are contingent claims on assets in place so that they are riskier and earn higher expected re- turns. Disinvestment options with costly reversibility reduce exposure to aggregate risks amid deteriorating business conditions and lower expected returns on a firm. The inextri- cable link between investment options and disinvestment options explains the coexistence of the profitability premium and the value premium while retains a positive relation between profitability and market valuation ratios. My model also generates a procyclical profitability premium and a countercyclical value premium. In the second essay, my co-authors and I investigate the joint asset pricing effects of variable costs and fixed costs in a firm’s production process. While the latter such as SG&A expenses create an operating leverage effect, the variable costs allow firms to hedge against aggregate profitability shocks. Taking into account both types of production costs explains the empir- ical patterns in the cross-section asset returns in portfolios sorted by the gross profitability and operating leverage. Our model reconciles the seemingly contradictory phenomena that higher productivity firms earn lower returns ( ̇Imrohoro ̆glu and T ̈uzel (2014)), whereas more profitable, often more productive, firms earn higher returns (Novy-Marx (2013)). It also of- fers a novel explanation for the negative idiosyncratic volatility premium (Ang et al. (2006)) based on production costs.



Economics, Finance