Growth Opportunities, Assets in Place, Stocks Migration and CAPM: A Rational Foundation for the Fama-French and Momentum Factors

33 Pages Posted: 17 Sep 2012 Last revised: 3 Nov 2012

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Date Written: March 1, 2012

Abstract

Can the Fama-French (1993) factors and Carhart’s (1997) momentum factor be derived from CAPM? Surprisingly, the answer is YES, once a basic form of stock market incompleteness is accounted for. Investors cannot trade growth opportunities (GOs) separately from net assets in place (NAIPs). Because shares are sold as bundled units containing set amounts of GOs and NAIPs, investors do not fulfill their potential demands for GOs and NAIPs “shares” when buying value and growth stocks. The mean reversion of profitability and price-to-book ratios that leads to predictable patterns of stock migration across cap and style categories (Fama and French, 2007) plays a key role in the analysis. The momentum factor is related to the temporary mean-aversion of price-to book ratios for stocks that transit through the neutral category.

Keywords: Market Incompleteness, CAPM, Fama and French, Three Factor Model, HML, SML, SMB, Momentum, Carhart, Migration, Size Premium, Value Premium, Growth Opportunities, Net Assets in Place, Book Value, Equity, Pent-up Demand, Carve-outs, Asset Impairments.

JEL Classification: G12

Suggested Citation

Faugère, Christophe, Growth Opportunities, Assets in Place, Stocks Migration and CAPM: A Rational Foundation for the Fama-French and Momentum Factors (March 1, 2012). 29th International Conference of the French Finance Association (AFFI) 2012, Available at SSRN: https://ssrn.com/abstract=2079557 or http://dx.doi.org/10.2139/ssrn.2079557

Christophe Faugère (Contact Author)

Kedge Business School Bordeaux ( email )

680 Cours de la Liberation
Bordeaux, Aquitaine 33405
France

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