Digesting Anomalies: An Investment Approach

Fisher College of Business Working Paper No. 2012-03-021

Charles A. Dice Center Working Paper No. 2012-021

95 Pages Posted: 26 Sep 2012 Last revised: 5 Dec 2012

Kewei Hou

Ohio State University (OSU) - Department of Finance

Chen Xue

University of Cincinnati

Lu Zhang

Ohio State University - Fisher College of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: December 4, 2012

Abstract

Motivated from investment-based asset pricing, we propose a new factor model that consists of the market factor, a size factor, an investment factor, and a return-on-equity factor. The new model [i] outperforms the Carhart (1997) four-factor model in pricing portfolios formed on earnings surprise, idiosyncratic volatility, financial distress, equity issues, as well as on investment and return-on-equity; [ii] performs similarly as the Carhart model in pricing portfolios on momentum as well as on size and book-to-market; but [iii] underperforms in pricing the total accrual deciles. Our model’s performance, combined with its clear economic intuition, suggests that it can serve as a new workhorse model for academic research and investment management practice.

Keywords: Asset pricing anomalies, investment, ROE, factor models, investment-based asset pricing

JEL Classification: G12, G14

Suggested Citation

Hou, Kewei and Xue, Chen and Zhang, Lu, Digesting Anomalies: An Investment Approach (December 4, 2012). Charles A. Dice Center Working Paper No. 2012-021. Available at SSRN: https://ssrn.com/abstract=2152674 or http://dx.doi.org/10.2139/ssrn.2152674

Kewei Hou

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-0552 (Phone)
614-292-2418 (Fax)

Chen Xue

University of Cincinnati ( email )

College of Business Administration
Cincinnati, OH 45221
United States
(513) 556-7078 (Phone)

Lu Zhang (Contact Author)

Ohio State University - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
585-267-6250 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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