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Market-Based Solutions to Vital Economic Issues

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Market-Based Solutions to Vital Economic Issues
Research
Jun 1, 2019

Aggregation, Capital Heterogeneity, and the Investment CAPM

Abstract

A detailed treatment of aggregation and capital heterogeneity substantially improves the performance of the investment CAPM. Firm-level predicted returns are constructed from firm-level accounting variables and aggregated to the portfolio level to match with portfolio-level stock returns. Working capital forms a separate productive input besides physical capital. The model fits well the value, momentum, investment, and profitability premiums simultaneously and partially explains positive stock-fundamental return correlations, the procyclical and short-term dynamics of the momentum and profitability premiums, as well as the countercyclical and long-term dynamics of the value and investment premiums. However, the model falls short in explaining momentum crashes.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.


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