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Digesting Anomalies: An Investment Approach

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  • Kewei Hou
  • Chen Xue
  • Lu Zhang

Abstract

Motivated from investment-based asset pricing, we propose a new factor model consisting of the market factor, a size factor, an investment factor, and a return on equity factor. The new factor model outperforms the Carhart four-factor model in pricing portfolios formed on earnings surprise, idiosyncratic volatility, financial distress, net stock issues, composite issuance, as well as on investment and return on equity. The new model performs similarly as the Carhart model in pricing portfolios formed on size and momentum, abnormal corporate investment, as well as on size and book-to-market, but underperforms in pricing the total accrual deciles. The new model's performance, combined with its clear economic intuition, suggests that it can be used as a new workhorse model for academic research and investment management practice.

Suggested Citation

  • Kewei Hou & Chen Xue & Lu Zhang, 2012. "Digesting Anomalies: An Investment Approach," NBER Working Papers 18435, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:18435
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    Cited by:

    1. Cederburg, Scott & O’Doherty, Michael S., 2015. "Asset-pricing anomalies at the firm level," Journal of Econometrics, Elsevier, vol. 186(1), pages 113-128.
    2. Lin, Xiaoji & Zhang, Lu, 2013. "The investment manifesto," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 351-366.
    3. Wagner, Alexander F. & Schrimpf, Paul & Schmidt, Peter S. & von Arx, Urs & Ziegler, Andreas, 2015. "Size and Momentum Profitability in International Stock Markets," CEPR Discussion Papers 10804, C.E.P.R. Discussion Papers.
    4. Lee, Edward & Strong, Norman & Zhu, Zhenmei (Judy), 2014. "Did the value premium survive the subprime credit crisis?," The British Accounting Review, Elsevier, vol. 46(2), pages 166-178.
    5. Fama, Eugene F. & French, Kenneth R., 2015. "A five-factor asset pricing model," Journal of Financial Economics, Elsevier, vol. 116(1), pages 1-22.
    6. Brisker, Eric R. & Autore, Don M. & Colak, Gonul & Peterson, David R., 2014. "Executive compensation structure and the motivations for seasoned equity offerings," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 330-345.
    7. Ferikawita M. Sembiring, 2018. "Three-Factor and Five-Factor Models: Implementation of Fama and French Model on Market Overreaction Conditions," GATR Journals jfbr150, Global Academy of Training and Research (GATR) Enterprise.
    8. Huang, Yuan & Lam, F.Y. Eric C. & Wei, K.C. John, 2014. "The q-theory explanation for the external financing effect: New evidence," Journal of Banking & Finance, Elsevier, vol. 49(C), pages 69-81.
    9. Humaira Asad & Faraz Khalid Cheema, 2017. "An Empirical Assessment of the Q-Factor Model: Evidence from the Karachi Stock Exchange," Lahore Journal of Economics, Department of Economics, The Lahore School of Economics, vol. 22(2), pages 117-138, July-Dec.

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    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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