| The model accounts for the observed value premium. When the firm faces non-convex adjustment costs of investment, deviations of its actual capital stock from its target stock of capital (DC) entail changes in the firm's conditional market beta. Book to market ratio serves as a proxy for DC. The model reproduces the cross-sectional and time series relationships between B/M and expected returns observed in the data. The paper provides empirical evidence that DC explains statistically significant and economically important time variation in firms' betas. |
