Working Paper: NBER ID: w18435
Authors: Kewei Hou; Chen Xue; Lu Zhang
Abstract: Motivated from investment-based asset pricing, we propose a new factor model consisting of the market factor, a size factor, an investment factor, and a return on equity factor. The new factor model outperforms the Carhart four-factor model in pricing portfolios formed on earnings surprise, idiosyncratic volatility, financial distress, net stock issues, composite issuance, as well as on investment and return on equity. The new model performs similarly as the Carhart model in pricing portfolios formed on size and momentum, abnormal corporate investment, as well as on size and book-to-market, but underperforms in pricing the total accrual deciles. The new model's performance, combined with its clear economic intuition, suggests that it can be used as a new workhorse model for academic research and investment management practice.
Keywords: factor model; asset pricing; investment; anomalies
JEL Codes: G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| q-factor model (C38) | pricing of portfolios (G11) |
| investment factor (G31) | expected returns (G17) |
| return on equity factor (D33) | expected returns (G17) |
| q-factor model (C38) | Fama-French alphas (G12) |
| high accrual firms (G32) | expected returns (G17) |