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


  • I am grateful to an anonymous reviewer for their extensive comments and suggestions leading to a significant improvement in the content and exposition of this paper. For helpful comments, I also thank seminar participants at the CRSP Forum 2010, Booth School of Business at the University of Chicago.


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.