A Productivity Augmented Capital Asset Pricing Approach to Anomaly Resolution

Abstract

Linear asset pricing models such as CAPM and the Fama-French 3-factor model rely on a linear approximation of marginal utility growth to discount expected returns. Unconditional estimations of these models are unable to explain the abnormal returns associated with simple strategies based on prior-return portfolios (momentum); and conditional estimations have not yet been applied to momentum strategies. This study demonstrates that conditional estimation of these models can explain the abnormal returns associated with momentum strategies when using a macroeconomic theory-derived and productivity-based marginal utility growth proxy as an instrument. Robustness tests show the productivity-augmented CAPM is also capable of explaining the size and value (book-to-market) anomalies. In addition to anomaly resolution, the results and methodology have practical applications in cost of capital estimation, executive compensation, and fraud detection.

Keywords: momentum, price momentum, earnings momentum, market efficiency, macroeconomy, macroeconomic, CAPM, asset pricing, productivity

JEL Classification: G11, G12, G14, M40