The Investment Opportunity Set and its Proxy Variables

We use a real options approach to evaluate the performance of proxy variables for a firmiquest;s investment opportunity set. The results show that on a relative scale, the market-to-book assets ratio outperforms all other proxy variables that we investigate. It has the highest information content with respect to investment opportunities, and it is least affected by other factors. Although both the market-to-book equity and the earnings-price ratios are related to investment opportunities, they do not contain information that is not already contained in the market-to-book assets ratio. Consistent with this finding, a common factor constructed from several proxy variables does not improve the performance of the market-to-book assets ratio