Download This PaperThe X-value factor - A tale of the systematic failure of academia in the real world
41 Pages Posted: 8 Apr 2019 Last revised: 5 Mar 2021
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The X-value factor - A tale of the systematic failure of academia in the real world
The X-Value Factor
Date Written: March 5, 2021
Abstract
This paper fixes the value investment strategy by following the simple, correct, but unpopular theoretical explanation of the value premium: X-value normalizes stock prices by the recursive out-of-sample expectation of each firm's net income, estimated by industry from its financials, while ignoring book equity. The resulting X-value factor is unspanned by the five Fama/French factors individually or in different combinations, and spans the value and investment factors. Its Sharpe ratio of 0.57 is the largest among the five factors, compared to 0.39 for value. However, the citation-oriented (as opposed to scientific-oriented) incentives in academia imply that academic popularity requires adherence to narratives that agree with the preferences of influential academics, regardless of scientific accuracy. Hence, this small example in the area of investments also illustrates a general tale of past - and a systematic prediction of future - failures of academic ``truths'' when faced with reality.
Keywords: Risk premiums, Fama and French, cash flow forecasting, out of sample.
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation