The Investment CAPM

Abstract

A new class of Capital Asset Pricing Models (CAPM) arises from the first principle of real investment for individual firms. Conceptually as ‘causal’ as the consumption CAPM, yet empirically more tractable, the investment CAPM emerges as a leading asset pricing paradigm. Firms do a good job in aligning investment policies with costs of capital, and this alignment drives many empirical patterns that are anomalous in the consumption CAPM. Most important, integrating the anomalies literature in finance and accounting with neoclassical economics, the investment CAPM has succeeded in mounting an efficient markets counterrevolution to behavioural finance over the past 15 years.

There are two very different accruals anomalies

“…Some interpret as evidence of mispricing the identification of a characteristic, such as accruals, that predicts the cross‐section of returns and is unexplained by extant risk factors. However, equation shows that profitability and investment should explain expected returns; the profitability and investment characteristics are no less causal in determining expected returns than exposures to risk factors (e.g., Lin & Zhang, ; Zhang, ).…”

The relation between bank credit growth and the expected returns of bank stocks

“…This paper also relates to three other distinct strands of the literature. First, my work relates to standard neoclassical models (such as Barro, ; Gabaix, ; Rietz, ; and Wachter, ) as well as classic models of investment behaviour (such as Abel, ; Abel & Blanchard, ; Lin & Zhang, ; Zhang, ). In these models, exogenous variation in the probability of a disaster causes discount rates to vary over time.…”

The profitability effect: Insights from international equity markets

“…He also provides some international evidence on the gross profitability effect. However, Zhang () shows that the gross profitability effect of Novy‐Marx () is not significant for annually rebalanced portfolios when annual gross profit is scaled by one‐year‐lagged total assets. He argues that it is more appropriate to scale gross profit by one‐period‐lagged assets.…”

“…We next examine how the profitability effect varies across countries in the context of predictions from behavioral finance and the investment capital asset pricing model (CAPM). As elaborated in Zhang (), behavioral finance, which relies on dysfunctional markets, predicts that profitability should be stronger in emerging markets and weaker in developed markets. The rationale is that investors in emerging markets are less sophisticated and markets are less efficient, with more severe limits to arbitrage.…”

“…We first examine whether extant findings on the profitability effect transfer beyond the USA and whether the size of this effect is sensitive to the denominator of profitability measures and portfolio sorts. We focus on the six measures of profitability commonly used in the literature: gross profitability of Novy‐Marx (), operating profitability of Fama and French (), operating profitability of Ball, Gerakos, Linnainmaa, and Nikolaev (), two lagged gross profitability measures of Zhang (), and the profitability measure of Hou, Xue, and Zhang ().…”