The Use of Asset Growth in Empirical Asset Pricing Models

Abstract

We show that the performance of the new factor models of Hou, Xue, and Zhang (2015) and Fama
and French (2015) depends crucially on how their investment factor is constructed. Both models
use growth in total assets to measure investment. Their ability to price the cross-section of returns
decreases significantly when the investment factor is constructed using traditional investment measures, or measures that also account for investment in intangibles. In contrast, we find that factors based on growth in inventory and accounts receivable contain the bulk of the pricing information in the asset growth factor. We show evidence that the superior performance of the asset growth factor seems to be attributable to its ability to capture aggregate shocks to equity financing costs.

Keywords: Anomalies, factor model, asset growth, investment, the q-factor model, dividend discount model, overextrapolation

JEL Classification: G12, G20