Asset pricing predictions from the investment CAPM depend on the cross-sectional relation between investment and profitability. In samples of U.S. stocks featuring high cross-sectional investment-profitability correlation, both investment and profitability premiums are weak. Consistent with the conditional predictions from the investment CAPM, triple sorts on size, investment, and profitability as in Hou et al. (2015)’s q-factors resurrect the premiums in the high-correlation samples. We find similar results using cash-based profitability, consistent with the dynamic investment CAPM. Our work has important implications for constructing asset pricing factors and interpreting out-of-sample asset pricing test results, in particular the insignificance of historical investment and profitability premiums.

Entrepreneurs often face undiversifiable idiosyncratic risks from their business investments. We extend the standard real options approach to an incomplete markets environment and analyze the joint decisions of business investments, consumption/savings, and portfolio selection. For a lump-sum investment payoff and an agent with a sufficiently strong precautionary savings motive, an increase in volatility can accelerate investment, contrary to the standard real options analysis. When the agent can trade the market portfolio to partially hedge against investment risk, the systematic volatility is compensated via the standard CAPM argument, and the idiosyncratic volatility generates a private equity premium. Finally, when the investment payoff is a series of flows, the agent's idiosyncratic risk exposure alters both the implied option value and the implied project value, causing a reversal of the results in the lump-sum payoff case.

This paper documents the emergence of a large bank loan market in the absence of contracting institutions: the trusted assistant loan market in 19th century China. These loans were legally unenforceable, one-shot loans to poor scholars that funded the costs of assuming lucrative administrative appointments offering ample opportunities for corruption. The trusted assistant loan’s distinguishing feature was a legally unenforceable stipulation that the borrower incorporate an agent of the creditor into his administrative cadre. We model the enforcement of these loans through expertise leverage and test the model’s predictions using data from officials’ diaries and a bank loan book.