Discussion paper

DP3058 An Investment-Growth Asset Pricing Model

In this paper we present a simple model where asset returns are functions of multiple
investment growth rates. The model is tested for its ability to price the 25 Fama-French
portfolios using the Generalized Methods of Moments (GMM) methodology, as well as
Fama-MacBeth cross-sectional regressions. Comparisons on the basis of several metrics
with other models, such as the CAPM, the Fama-French (1993) model and Cochrane's
(1996) model, reveal that it consistently outperforms the CAPM and Cochrane's model. It
also outperforms the Fama-French model in several tests. Our model can explain a
significantly larger proportion of the cross-sectional variation in the 25 Fama-French
portfolios than the Fama-French model does. Specification tests in the context of GMM
and the Fama-MacBeth regressions show that in the presence of the investment growth
factors included in our model, the size and book-to-market characteristics lose their
ability to explain asset returns. Our model is successful in pricing size- and book-to-market-
sorted portfolios, although it includes exclusively macroeconomic variables as
factors.

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Citation

Vassalou, M, Q Li and Y Xing (2001), ‘DP3058 An Investment-Growth Asset Pricing Model‘, CEPR Discussion Paper No. 3058. CEPR Press, Paris & London. https://cepr.org/publications/dp3058