Asset growth, profitability, and investment opportunities

Ilan Cooper; Paulo Maio

doi:10.1287/mnsc.2018.3036

Asset growth, profitability, and investment opportunities

Research output: Contribution to journal › Article › peer-review

Abstract

We show that recent prominent equity factor models are to a large degree compatible with the Intertemporal CAPM (ICAPM) framework. Factors associated with alternative profitability measures forecast the equity premium in a way that is consistent with the ICAPM. Several factors based on firms’ asset growth predict a significant decline in stock market volatility, thus being consistent with their positive prices of risk. The investment-based factors are also strong predictors of an improvement in future economic activity. The time-series predictive ability of most equity state variables is not subsumed by traditional ICAPM state variables. Importantly, factors that earn larger risk prices tend to be associated with state variables that are more correlated with future investment opportunities or economic activity. Moreover, these risk price estimates can be reconciled with plausible risk-aversion parameter estimates. Overall, the ICAPM can be used as a common theoretical background for recent multifactor models.

Original language	English
Pages (from-to)	3988-4010
Number of pages	23
Journal	Management Science
Volume	65
Issue number	9
DOIs	https://doi.org/10.1287/mnsc.2018.3036
State	Published - 1 Sep 2019
Externally published	Yes

Bibliographical note

Funding Information:
The authors thank two anonymous referees, an anonymous associate editor, Karl Diether (the department editor), Jean-Sebastien Fontaine, Benjamin Holcblat, Soren Hvidkjaer, Markku Kaustia, Matthijs Lof, Salvatore Miglietta, Johann Reindl, and Costas Xiouros, as well as participants at the 2015 BEROC Conference (Minsk), 2015 FEBS Conference (Nantes), 2015 EFA (Vienna), BI CAPR Seminar, Helsinki Finance Seminar (Aalto University), 2016 MFA (Atlanta), and 2016 WFC (New York) for helpful comments. The authors are grateful to Kenneth French, Amit Goyal, Robert Novy-Marx, Robert Shiller, and Lu Zhang for providing stock market and economic data. A previous version of this paper was titled “Equity Risk Factors and the Intertemporal CAPM.” Any remaining errors are our own.

Publisher Copyright:
© 2019 INFORMS.

Keywords

Asset pricing models
Cross section of stock returns
Equity risk factors
Intertemporal CAPM
Predictability of stock returns
Stock market anomalies

ASJC Scopus subject areas

Strategy and Management
Management Science and Operations Research

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10.1287/mnsc.2018.3036

Cite this

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title = "Asset growth, profitability, and investment opportunities",

abstract = "We show that recent prominent equity factor models are to a large degree compatible with the Intertemporal CAPM (ICAPM) framework. Factors associated with alternative profitability measures forecast the equity premium in a way that is consistent with the ICAPM. Several factors based on firms{\textquoteright} asset growth predict a significant decline in stock market volatility, thus being consistent with their positive prices of risk. The investment-based factors are also strong predictors of an improvement in future economic activity. The time-series predictive ability of most equity state variables is not subsumed by traditional ICAPM state variables. Importantly, factors that earn larger risk prices tend to be associated with state variables that are more correlated with future investment opportunities or economic activity. Moreover, these risk price estimates can be reconciled with plausible risk-aversion parameter estimates. Overall, the ICAPM can be used as a common theoretical background for recent multifactor models.",

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author = "Ilan Cooper and Paulo Maio",

note = "Funding Information: The authors thank two anonymous referees, an anonymous associate editor, Karl Diether (the department editor), Jean-Sebastien Fontaine, Benjamin Holcblat, Soren Hvidkjaer, Markku Kaustia, Matthijs Lof, Salvatore Miglietta, Johann Reindl, and Costas Xiouros, as well as participants at the 2015 BEROC Conference (Minsk), 2015 FEBS Conference (Nantes), 2015 EFA (Vienna), BI CAPR Seminar, Helsinki Finance Seminar (Aalto University), 2016 MFA (Atlanta), and 2016 WFC (New York) for helpful comments. The authors are grateful to Kenneth French, Amit Goyal, Robert Novy-Marx, Robert Shiller, and Lu Zhang for providing stock market and economic data. A previous version of this paper was titled “Equity Risk Factors and the Intertemporal CAPM.” Any remaining errors are our own. Publisher Copyright: {\textcopyright} 2019 INFORMS.",

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Asset growth, profitability, and investment opportunities

Abstract

Bibliographical note

Keywords

ASJC Scopus subject areas

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