Andrew B. Abel

Andrew B Abel (Work In Progress), Tobin’s q and Optimal Dividends, Investment, and Liquidity in a Financially-Constrained Firm.

Andrew B Abel (2018), The Effects of q and Cash Flow on Investment in the Presence of Measurement Error, Journal of Financial Economics, 128 (2), pp. 363-377. https://doi.org/10.1016/j.jfineco.2018.02.005

Abstract: I analyze investment, q, and cash flow in a tractable stochastic model in which marginal q and average q are identically equal. I introduce classical measurement error and derive closed-form expressions for the coefficients in regressions of investment on q and cash flow. The cash-flow coefficient is positive and larger for faster growing firms, yet there are no financial frictions in the model. I develop the concepts of bivariate attenuation and weight shifting to interpret the estimated coefficients on q and cash flow in the presence of measurement error.

Andrew B Abel (Draft), Classical Measurement Error with Several Regressors.

Abstract: In OLS regressions with several regressors, measurement error affects estimated coefficients through two distinct channels: a multivariate attenuation factor that applies to all coefficients and generalizes the standard attenuation factor in univariate regressions; weight shifting associated with measurement error on each mismeasured regressor that further attenuates the coefficient on that regressor and affects coefficients on other regressors. I introduce a scalar "measurement error multiplier" that indicates the contribution of measurement error to the generalized variance of the measured regressors. It multiplies the variances of the measurement errors where it appears in both the multivariate attenuation channel and the weight shifting channel.

Andrew B Abel (2017), Crowding Out in Ricardian Economies, Journal of Monetary Economics, 87 (), pp. 52-66. https://doi.org/10.1016/j.jmoneco.2017.03.002

Abstract: The crowding-out coefficient is the ratio of the reduction in privately-issued bonds to the increase in government bonds that are issued to finance a tax cut. If (1) Ricardian equivalence holds, and (2) households do not simultaneously borrow risklessly and have positive gross positions in other riskless assets, the crowding-out coefficient equals the fraction of the aggregate tax cut that accrues to households that borrow. In the conventional case in which all households receive equal tax cuts, the crowding-out coefficient equals the fraction of households that borrow. In the United States, about 75\% of households borrow, so the crowding-out coefficient is predicted to be 0.75, which differs from econometric estimates that are around 0.5. I explore extensions of the model, such as a departure from Ricardian Equivalence or the introduction of cross-sectional variation in taxes, that might account for this difference.

Andrew B Abel (2017), Optimal Debt and Profitability in the Tradeoff Theory, Journal of Finance, 73 (1), pp. 95-143. https://doi.org/10.1111/jofi.12590

Abstract: I develop a dynamic model of leverage with tax deductible interest and an endogenous cost of default. The interest rate includes a premium to compensate lenders for expected losses in default. A borrowing constraint is generated by lenders’ unwillingness to lend an amount that would trigger immediate default. When the borrowing constraint is not binding, the tradeoff theory of debt holds: optimal debt equates the marginal tax shield and the marginal expected cost of default. Contrary to conventional interpretation, but consistent with empirical findings, increases in current or future profitability reduce the optimal leverage ratio when the tradeoff theory holds.

Andrew B Abel, Ben S. Bernanke, Dean Croushore, Macroeconomics, 9th edition (: Addison, Wesley, Longman, 2017)

Andrew B Abel (Working), Investment with Leverage.

Abstract: I examine the capital investment and leverage decisions of a firm. Optimal leverage depends on the interest tax shield and the cost of exposure to default, subject to an endogenous borrowing constraint. When the borrowing constraint is not binding, the tradeoff theory is operative; in that case, the market leverage ratio is a declining function of profitability, consistent with empirical findings. Bond financing increases q and investment, but given q, optimal investment and optimal leverage are independent. A novel expression for marginal q includes the expected present value of interest tax shields.

Andrew B Abel, Janice C. Eberly, Stavros Panageas (2013), Optimal Inattention to the Stock Market with Information Costs and Transactions Costs, Econometrica, 81 (4), pp. 1455-1481. https://doi.org/10.3982/ECTA7624

Abstract: Recurrent intervals of inattention to the stock market are optimal if consumers incur a utility cost to observe asset values. When consumers observe the value of their wealth, they decide whether to transfer funds between a transactions account from which consumption must be financed and an investment portfolio of equity and riskless bonds. Transfers of funds are subject to a transactions cost that reduces wealth and consists of two components: one is proportional to the amount of assets transferred, and the other is a fixed resource cost. Because it is costly to transfer funds, the consumer may choose not to transfer any funds on a particular observation date. In general, the optimal adjustment rule—including the size and direction of transfers, and the time of the next observation—is state-dependent. Surprisingly, unless the fixed resource cost of transferring funds is large, the consumer’s optimal behavior eventually evolves to a situation with a purely time-dependent rule with a constant interval of time between observations. This interval of time can be substantial even for tiny observation costs. When this situation is attained, the standard consumption Euler equation holds between observation dates if the consumer is sufficiently risk averse.

Andrew B Abel and Janice C. Eberly (2012), Investment, Valuation, and Growth Options, Quarterly Journal of Finance, 32. 10.1142/S2010139212500012

Abstract: We develop a model in which the opportunity for a firm to upgrade its technology to the frontier (at a cost) leads to growth options in the firm's value; that is, a firm's value is the sum of value generated by its current technology plus the value of the option to upgrade. Variation in the technological frontier leads to variation in firm value that is unrelated to current cash flow and investment, though variation in firm value anticipates future upgrades and investment. We simulate this model and show that, consistent with the empirical literature, in situations in which growth options are important, regressions of investment on Tobin's Q and cash flow yield small positive coefficients on Q and larger coefficients on cash flow. We also show that growth options increase the volatility of firm value relative to the volatility of cash flow.

Andrew B Abel and Janice C. Eberly (2011), How Q and Cash Flow Affect Investment with Frictions: An Analytic Explanation, The Review of Economic Studies, 78 (4), 1179-1200 (). https://doi.org/10.1093/restud/rdr006