The Cross-Section of Investment and Profitability: Implications for Asset Pricing

55 Pages Posted: 24 Sep 2019 Last revised: 9 May 2022

See all articles by Mete Kilic

Mete Kilic

University of Southern California - Marshall School of Business

Louis Yang

Cubist Systematic Strategies

Miao Ben Zhang

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Date Written: May 18, 2021

Abstract

Asset pricing predictions from the investment CAPM depend on the cross-sectional relation between investment and profitability. In samples of U.S. stocks featuring high cross-sectional investment-profitability correlation, both investment and profitability premiums are weak. Consistent with the conditional predictions from the investment CAPM, triple sorts on size, investment, and profitability as in Hou, Xue, and Zhang (2015)'s q-factors mitigate this impact and resurrect premiums in the high-correlation samples. We find similar results using cash-based profitability, consistent with the investment CAPM in a dynamic setting. Our work has important implications for constructing asset pricing factors and offers guidance on interpreting out-of-sample asset pricing test results.

Keywords: Investment CAPM; Cross-Section of Stock Returns; q-Factors; Investment Premium; Profitability Premium; Out-of-Sample Test.

JEL Classification: G10, G12, G31, D92

Suggested Citation

Kilic, Mete and Yang, Louis and Zhang, Miao Ben, The Cross-Section of Investment and Profitability: Implications for Asset Pricing (May 18, 2021). Available at SSRN: https://ssrn.com/abstract=3447685 or http://dx.doi.org/10.2139/ssrn.3447685

Mete Kilic

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA California 90089
United States

Louis Yang

Cubist Systematic Strategies ( email )

55 Hudson Yards
10th Floor
New York, NY 10001
United States

Miao Ben Zhang (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

HOME PAGE: http://www.MiaoBenZhang.com/

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