Do the Investment and Return‐on‐Equity Factors Proxy for Economic Risks?

Abstract

We study the information content of two new return factors, the investment factor (IA) and the return‐on‐equity factor (ROE), as proposed by Chen, Novy‐Marx, and Zhang in 2011. First, IA is a strong predictor for future gross domestic product (GDP) growth despite the presence of other financial and economic variables. IA subsumes the pricing power of the GDP factor for the cross section of asset returns. Second, ROE is closely related to innovations in dividend yield and term spread. When modeled together with innovations in state variables that forecast future investment opportunities, IA and ROE lose their explanatory power.

Enterprise risk management and firm value within China’s insurance industry

“…Thus instead return on equity (ROE), which refers to the return on portfolios, is employed. Studies by Wang (2013), for example, suggest that under linear homogeneity assumptions, there is a direct correlation between firm value (measured as the performance of a new investment portfolio) and ROE. Based on this, ROE has been employed by earlier scholars such as Chen et al (2008) and Nieh, Yau and Liu (2008) as a measure of firm value.…”

The Impact of Going Public Decision on Company Performance: Evidence from Pakistan

“…Clarification was provided then that ROE is not good in finding GDP growth but good to determine the price (Z. Wang, 2013). ROA was also included in FFM later on, and the results then become better than before (Chen & Novy-Marx, 2011).…”

Productivity Risk and Industry Momentum

“…This paper also contributes to the broader literature that identifies several risk factors for the cross‐section of stock returns using the ICAPM, including Campbell (), Campbell and Vuolteenaho (), Ang, Hodrick, Xing, and Zhang (), Petkova (), Adrian and Rosenberg (), Wang () and Campbell, Giglio, Polk, and Turley (). Similar to these papers, this work reveals the pricing ability of a plausible ICAPM innovation in the cross‐section of an important stock market anomaly.…”

“…Petkova () finds that when loadings on the innovations in the predictive variables are present in her empirical model, loadings on the HML and SMB factors lose their explanatory power for the cross‐section of returns. In a closely related paper, Wang () analyzes the information of the content of investment (IA) and profitability (ROE) factors. When he models them together with innovations in state variables that forecast future investment opportunities, he finds that IA and ROE lose their explanatory power as well.…”