An Augmented q-Factor Model with Expected Growth*

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, Rev. Finan. Stud., 28, 650–705) q-factor model with the expected growth factor, shows strong explanatory power in the cross-section and outperforms the Fama–French (2018, J. Finan. Econom., 128, 234–252) six-factor model.

An augmented capital asset pricing model using new macroeconomic determinants

“…That study proposed a two-coefficient model by adding an intercept coefficient alpha (α) to the original CAPM to represent the stock's expected excess return when the market risk premium is zero (α equals zero in an efficient market). Recent studies confirmed the alpha existed for the real stocks ( Barillas and Shanken, 2017 ; Fama and French, 1996b , 2015 ; 2018 ; Hou et al., 2015 , 2020b ; Hou et al., 2019 , 2020a ; Pham and Phuoc, 2020 ; Phuoc, 2018 ; Zhang, 2017 ). However, that study does not explore and capture other risks such as the firm's financial ratios and investment, stock momentum, and macroeconomic risks.…”

“…(2019) revised the by adding one more factor, the expected investment growth. Their new model, the ( Hou et al., 2020a , Hou et al., 2020b ), yielded strong explanatory power in the cross-section and outperformed the , FF5, FF6, and the Barillas and Shanken (2018) ' six-factor model in terms of maximum Sharpe ratio.…”

“…(1) includes the excess market return of the original CAPM and the U.S. prime rate, the U.S. government long-term bond rate, and the exchange rate of USD/EUR. Importantly, this MAPM is inspired by and based on the macroeconomic theory and models, a requirement for an asset pricing model as suggested by other studies ( Hou et al., 2020a , Hou et al., 2020b ; Fama and French, 2018 ). Then, we employed the quantitative research method using the Bayesian approach to confirm our proposed model, the MAPM.…”

“…Also, only the S&P 500 stocks, the largest U.S stocks, were purposefully employed in this study to examine the performance of both the MAPM and CAPM and the three proposed macroeconomic determinants. The reason is to minimize the faulty anomalies claim with microcap stocks that discovered in a recent study ( Hou et al., 2020a , Hou et al., 2020b ).…”

“…Finally, unlike the recent asset-pricing model studies ( Barillas and Shanken, 2017 , 2018 ; Fama and French, 2015 , 2016 , 2018 ; Hou et al., 2019 , 2020a,b), we employed both the confidence interval approach instead of p -value and test hurdle of the absolute t -statistic of both 2.78 and 3.0 in our asset pricing model comparisons ( Dyckman, 2016 ; Dyckman and Zeff, 2019 ; Halsey, 2019 ; Harvey et al., 2015 ; Hou et al., 2020a , Hou et al., 2020b ; Lewellen et al., 2010 ; Wasserstein and Lazar, 2016 ).…”