An Augmented q-Factor Model with Expected Growth

Hou, Kewei; Mo, Haitao; Xue, Chen; Zhang, Lu

An Augmented q-Factor Model with Expected Growth

Review of Finance, Forthcoming

54 Pages Posted: 19 Mar 2020

See all articles by Kewei Hou

Kewei Hou

Ohio State University (OSU) - Department of Finance

Haitao Mo

Louisiana State University, Baton Rouge - E.J. Ourso College of Business Administration

Lu Zhang

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

Date Written: January 27, 2020

Abstract

In the investment theory, firms with high expected investment growth earn higher expected returns than firms with low expected investment growth, holding investment and expected profitability constant. Building on cross-sectional growth forecasts with Tobin’s q, operating cash flows, and change in return on equity as predictors, an expected growth factor earns an average premium of 0.84% per month (t = 10.27) in the 1967–2018 sample. The q5 model, which augments the Hou-Xue-Zhang (2015) q-factor model with the expected growth factor, shows strong explanatory power in the cross section and outperforms the Fama-French (2018) 6-factor model.

Keywords: The expected growth factor, factor models, the q5 model, the investment theory

JEL Classification: G12, G14

Suggested Citation: Suggested Citation

Hou, Kewei and Mo, Haitao and Xue, Chen and Zhang, Lu, An Augmented q-Factor Model with Expected Growth (January 27, 2020). Review of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3525435