The Use of Asset Growth in Empirical Asset Pricing Models
69 Pages Posted: 28 Aug 2017 Last revised: 22 Nov 2017
Date Written: November 21, 2017
We provide evidence that the empirical performance of the new factor models proposed by Hou, Xue, and Zhang (2015) and Fama and French (2015) depends crucially on how their investment factor is constructed. Specifically, we call attention to the fact that, in both models, the investment factor is based on the measure of growth in total assets from Cooper, Gulen, and Schill (2008) and not on what most researchers would view as traditional measures of corporate investment. For both models, we show that there are large decreases in their ability to price the cross-section of returns when the investment factor is instead constructed using the traditional investment measures, or when it is constructed using arguably more complete measures that account for investment in intangibles. Additionally, we do not find a significant decrease in performance when we replace the asset-growth factor with a factor based on growth in noncash current assets or long-term debt (which cannot be complete measures of investment). Our results challenge the idea that traditional investment models can fully account for the explanatory power of the asset-growth factor used in the Hou, Xue, and Zhang (2015) and Fama and French (2015) models.
Keywords: Anomalies, factor model, asset growth, investment, the q-factor model, dividend discount model
JEL Classification: G12
Suggested Citation: Suggested Citation