IDEAS home Printed from https://ideas.repec.org/a/eee/empfin/v46y2018icp1-10.html
   My bibliography  Save this article

Investment and profitability versus value and momentum: The price of residual risk

Author

Listed:
  • Li, Yuming

Abstract

Barillas and Shanken (2017) show that a traded factor is redundant if the intercept (alpha) in the regression of the factor on other factors is zero. I find that covariance-based asset pricing models imply that the alpha is proportional to the residual risk of the traded factor. Empirical estimation of the price of the residual risk suggests that the q-factor model of Hou et al. (2015) subsumes the roles of not only the value and momentum factors but also the investment and profitability factors of Fama and French (2015). However, the Fama–French (2015) model fails to subsume the roles of the momentum factor and the factors in the q-factor model. The momentum factor, along with the profitability factor in the Fama–French (2015) or Novy-Marx (2013) model does not subsume the role of the profitability factor in the q-factor model.

Suggested Citation

  • Li, Yuming, 2018. "Investment and profitability versus value and momentum: The price of residual risk," Journal of Empirical Finance, Elsevier, vol. 46(C), pages 1-10.
    • Handle: RePEc:eee:empfin:v:46:y:2018:i:c:p:1-10
    DOI: 10.1016/j.jempfin.2017.12.001
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0927539817301196
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.jempfin.2017.12.001?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Stephen A. Ross, 2013. "The Arbitrage Theory of Capital Asset Pricing," World Scientific Book Chapters, in: Leonard C MacLean & William T Ziemba (ed.), HANDBOOK OF THE FUNDAMENTALS OF FINANCIAL DECISION MAKING Part I, chapter 1, pages 11-30, World Scientific Publishing Co. Pte. Ltd..
    2. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    3. De Santis, Giorgio & Gerard, Bruno, 1997. "International Asset Pricing and Portfolio Diversification with Time-Varying Risk," Journal of Finance, American Finance Association, vol. 52(5), pages 1881-1912, December.
    4. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(1), pages 122-150, February.
    5. Novy-Marx, Robert, 2013. "The other side of value: The gross profitability premium," Journal of Financial Economics, Elsevier, vol. 108(1), pages 1-28.
    6. Kewei Hou & Chen Xue & Lu Zhang, 2015. "Editor's Choice Digesting Anomalies: An Investment Approach," The Review of Financial Studies, Society for Financial Studies, vol. 28(3), pages 650-705.
    7. Fama, Eugene F. & French, Kenneth R., 2015. "A five-factor asset pricing model," Journal of Financial Economics, Elsevier, vol. 116(1), pages 1-22.
    8. Guo, Hui & Savickas, Robert & Wang, Zijun & Yang, Jian, 2009. "Is the Value Premium a Proxy for Time-Varying Investment Opportunities? Some Time-Series Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(1), pages 133-154, February.
    9. Titman, Sheridan & Wei, K. C. John & Xie, Feixue, 2004. "Capital Investments and Stock Returns," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(4), pages 677-700, December.
    10. Eugene F. Fama & Kenneth R. French, 2008. "Dissecting Anomalies," Journal of Finance, American Finance Association, vol. 63(4), pages 1653-1678, August.
    11. Harvey, Campbell R, 1991. "The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-157, March.
    12. Carhart, Mark M, 1997. "On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    13. Huang, Lin & Wang, Zijun, 2014. "Is the investment factor a proxy for time-varying investment opportunities? The US and international evidence," Journal of Banking & Finance, Elsevier, vol. 44(C), pages 219-232.
    14. Eugene F. Fama & Kenneth R. French, 2016. "Dissecting Anomalies with a Five-Factor Model," The Review of Financial Studies, Society for Financial Studies, vol. 29(1), pages 69-103.
    15. Michael J. Cooper & Huseyin Gulen & Michael J. Schill, 2008. "Asset Growth and the Cross‐Section of Stock Returns," Journal of Finance, American Finance Association, vol. 63(4), pages 1609-1651, August.
    16. Fama, Eugene F & French, Kenneth R, 1996. "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    17. Maio, Paulo & Santa-Clara, Pedro, 2012. "Multifactor models and their consistency with the ICAPM," Journal of Financial Economics, Elsevier, vol. 106(3), pages 586-613.
    18. Fama, Eugene F. & French, Kenneth R., 2006. "Profitability, investment and average returns," Journal of Financial Economics, Elsevier, vol. 82(3), pages 491-518, December.
    19. Yuhang Xing, 2008. "Interpreting the Value Effect Through the Q-Theory: An Empirical Investigation," The Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1767-1795, July.
    20. Harvey, Campbell R., 1989. "Time-varying conditional covariances in tests of asset pricing models," Journal of Financial Economics, Elsevier, vol. 24(2), pages 289-317.
    21. Christopher Polk & Paola Sapienza, 2009. "The Stock Market and Corporate Investment: A Test of Catering Theory," The Review of Financial Studies, Society for Financial Studies, vol. 22(1), pages 187-217, January.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Marie Brière & Ariane Szafarz, 2021. "When it rains, it pours: Multifactor asset management in good and bad times," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 44(3), pages 641-669, September.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Lu Zhang, 2017. "The Investment CAPM," European Financial Management, European Financial Management Association, vol. 23(4), pages 545-603, September.
    2. Ilan Cooper & Paulo Maio, 2019. "Asset Growth, Profitability, and Investment Opportunities," Management Science, INFORMS, vol. 65(9), pages 3988-4010, September.
    3. Rocciolo, Francesco & Gheno, Andrea & Brooks, Chris, 2022. "Explaining abnormal returns in stock markets: An alpha-neutral version of the CAPM," International Review of Financial Analysis, Elsevier, vol. 82(C).
    4. Clarke, Charles, 2022. "The level, slope, and curve factor model for stocks," Journal of Financial Economics, Elsevier, vol. 143(1), pages 159-187.
    5. Hou, Kewei & Xue, Chen & Zhang, Lu, 2017. "Replicating Anomalies," Working Paper Series 2017-10, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    6. Wikrom Prombutr & Chanwit Phengpis & Ying Zhang, 2023. "Anomalies in U.S. REIT Returns: Evidence for and against the Q-theory," International Real Estate Review, Global Social Science Institute, vol. 26(1), pages 43-71.
    7. Kaserer Christoph & Hanauer Matthias X., 2017. "25 Jahre Fama-French-Modell: Erklärungsgehalt, Anomalien und praktische Implikationen," Perspektiven der Wirtschaftspolitik, De Gruyter, vol. 18(2), pages 98-116, June.
    8. Adam Zaremba & Jacob Koby Shemer, 2018. "Price-Based Investment Strategies," Springer Books, Springer, number 978-3-319-91530-2, January.
    9. Sadok El Ghoul & Omrane Guedhami & Sattar A. Mansi & Oumar Sy, 2023. "Event studies in international finance research," Journal of International Business Studies, Palgrave Macmillan;Academy of International Business, vol. 54(2), pages 344-364, March.
    10. Mateus, Irina B. & Mateus, Cesario & Todorovic, Natasa, 2019. "Review of new trends in the literature on factor models and mutual fund performance," International Review of Financial Analysis, Elsevier, vol. 63(C), pages 344-354.
    11. Kewei Hou & Haitao Mo & Chen Xue & Lu Zhang, 2019. "Which Factors?," Review of Finance, European Finance Association, vol. 23(1), pages 1-35.
    12. Joachim Freyberger & Andreas Neuhierl & Michael Weber, 2020. "Dissecting Characteristics Nonparametrically," The Review of Financial Studies, Society for Financial Studies, vol. 33(5), pages 2326-2377.
    13. Stephen A. Gorman & Frank J. Fabozzi, 2021. "The ABC’s of the alternative risk premium: academic roots," Journal of Asset Management, Palgrave Macmillan, vol. 22(6), pages 405-436, October.
    14. Robert F. Stambaugh & Yu Yuan, 2017. "Mispricing Factors," The Review of Financial Studies, Society for Financial Studies, vol. 30(4), pages 1270-1315.
    15. Franke, Benedikt & Müller, Sebastian & Müller, Sonja, 2017. "The q-factors and expected bond returns," Journal of Banking & Finance, Elsevier, vol. 83(C), pages 19-35.
    16. Maio, Paulo & Silva, André C., 2020. "Asset pricing implications of money: New evidence," Journal of Banking & Finance, Elsevier, vol. 120(C).
    17. Calvet, Laurent E. & Betermier, Sebastien & Jo, Evan, 2019. "A Supply and Demand Approach to Equity Pricing," CEPR Discussion Papers 13974, C.E.P.R. Discussion Papers.
    18. Guo, Bin & Zhang, Wei & Zhang, Yongjie & Zhang, Han, 2017. "The five-factor asset pricing model tests for the Chinese stock market," Pacific-Basin Finance Journal, Elsevier, vol. 43(C), pages 84-106.
    19. Wahal, Sunil, 2019. "The profitability and investment premium: Pre-1963 evidence," Journal of Financial Economics, Elsevier, vol. 131(2), pages 362-377.
    20. Söhnke M. Bartram & Harald Lohre & Peter F. Pope & Ananthalakshmi Ranganathan, 2021. "Navigating the factor zoo around the world: an institutional investor perspective," Journal of Business Economics, Springer, vol. 91(5), pages 655-703, July.

    More about this item

    Keywords

    Risk price; Traded factors; Anomalies;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:empfin:v:46:y:2018:i:c:p:1-10. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jempfin .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.