Two essays on asset pricing
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Chapter one of the thesis studies the relationship between corporate cash holdings and expected stock returns. I develop a real options model with external financing costs to relate endogenous firm cash holding policy to expected returns. In the model, firms choose to hold cash optimally to finance investments when productivity is high; and to provide liquidity when productivity is low. The optimal cash holding policy implies a positive relationship between cash-to-assets ratios of firms and expected returns. In addition, I show this positive relation is conditional in nature: it is stronger when cash flow risk dominates the total risk of firms; the positive relation diminishes as firms derive more risk from the investment channel. Using a data set of U.S. pubic companies, I provide empirical support for the predictions of the model. Chapter two investigates the role of intangible capital for firm valuation and risk in the cross section of publicly traded firms. Intangible capital is a durable production factor that is costly to accumulate, hard to evaluate, and cannot be easily transferred among firms. I develop a model that firms are endowed with fixed amounts of intangible capital and employ both tangible and intangible capital to produce. Firms incur fixed operating costs that are proportional to intangible capital stock levels. The fixed operating costs introduce operating leverage. In the model, firms with more intangible capital are burdened with more nonproductive capital and face greater operating leverage in bad times. In order to test the model prediction empirically, I construct an empirical measure of intangible capital stock at firm level and show that firms with more intangible capital have average returns that are 0:32% higher than firms with less intangible capital per month.