How can the Investment CAPM Price Momentum?

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A cura di Jack Vogel, PHD

How can a q-theoretic model price momentum?” is a new paper by Robert Novy-Marx and goes right to the heart of an intense debate ongoing in empirical asset pricing — can neoclassic economic models explain the so-called momentum anomaly?

A quote from the start of the paper, which answers the question of “Can the investment CAPM price momentum?”

“The answer, of course, is that it can’t” — Sentence one of the abstract

So a reader quickly gets the answer!

This paper questions some of the findings in Lu Zhang’s Replicating Anomalies paper. For those unfamiliar with Lu’z research, we have highlighted the replicating anomalies paper here and Wes has a long interview with Lu here (as well as an interview on a podcast). High-level, Lu’s Investment CAPM (also know as the q-factor model) says that the cross-section of expected returns should be explained by two main factors, (1) Investment and (2) Expected Profitability.(2) Lu adds the market and size as the third and fourth factors when empirically examining the cross-section of returns.

In the Replicating Anomalies paper, Lu mentions that his model with his four factors can explain almost all of the anomalies! And the list is long, as they test 447 anomalies! A few of the factors that they can explain are (1) Gross-Profitability and (2) Momentum (both Price and Fundamental Momentum).

Enter Rober Novy-Marx.


Well, here are some of his papers:

  1. The Other Side of Value: The Gross Profitability Premium. (JFE 2013)
  2. Fundamentally, Momentum is Fundamental Momentum (working paper, described on our site here)

So basically, we have two academics arguing over whose factors is more important in explaining the cross-section of stock returns.

Hence, we have an academic war (of sorts).(3)

So does the Investment CAPM (i.e. the q-factor model) really price the (1) Gross-Profitability factor and (2) the Momentum Factor?(4)

We dig into the paper below to find out more …

The Paper Set-up and Results

The paper begins by highlighting two of the main results in the Replicating Anomalies paper:

  1. The “expected profitability” factor (as measured by ROE) yields significant excess returns, even as measured by the 3 and 4-factor models.
  2. The q-factor model prices Price Momentum (UMD).

This is shown in Table 1 of the paper (highlighted below):

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