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The investment manifesto

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  • Lin, Xiaoji
  • Zhang, Lu

Abstract

A deep-ingrained doctrine in asset pricing says that if an empirical characteristic-return relation is consistent with investor “rationality,” the relation must be “explained” by a risk (factor) model. The investment approach questions the doctrine. Factors formed on characteristics are not necessarily risk factors; characteristics-based factor models are linear approximations of firm-level investment returns. The evidence that characteristics dominate covariances in horse races does not necessarily mean mispricing; measurement errors in covariances are likely to blame. Most important, risks do not “determine” expected returns; the investment approach is no more and no less “causal” than the consumption approach in “explaining” anomalies.

Suggested Citation

  • Lin, Xiaoji & Zhang, Lu, 2013. "The investment manifesto," Journal of Monetary Economics, Elsevier, vol. 60(3), pages 351-366.
  • Handle: RePEc:eee:moneco:v:60:y:2013:i:3:p:351-366
    DOI: 10.1016/j.jmoneco.2013.01.001
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Hou, Kewei & Xue, Chen & Zhang, Lu, 2012. "Digesting Anomalies: An Investment Approach," Working Paper Series 2012-21, Ohio State University, Charles A. Dice Center for Research in Financial Economics.
    2. repec:eee:jfinec:v:125:y:2017:i:2:p:326-343 is not listed on IDEAS
    3. Cooper, Ilan & Priestley, Richard, 2016. "The expected returns and valuations of private and public firms," Journal of Financial Economics, Elsevier, vol. 120(1), pages 41-57.
    4. Frank, Murray Z. & Shen, Tao, 2016. "Investment and the weighted average cost of capital," Journal of Financial Economics, Elsevier, vol. 119(2), pages 300-315.
    5. repec:eee:jfinec:v:128:y:2018:i:1:p:148-163 is not listed on IDEAS
    6. Lu Zhang, 2017. "The Investment CAPM," NBER Working Papers 23226, National Bureau of Economic Research, Inc.
    7. repec:eee:joacli:v:34:y:2015:i:c:p:39-57 is not listed on IDEAS
    8. Lu Zhang & Howard Kung & Hang Bai, 2013. ""Shooting" the CAPM," 2013 Meeting Papers 905, Society for Economic Dynamics.
    9. Huang, Lin & Wang, Zijun, 2014. "Is the investment factor a proxy for time-varying investment opportunities? The US and international evidence," Journal of Banking & Finance, Elsevier, vol. 44(C), pages 219-232.
    10. Kozak, Serhiy & Nagel, Stefan & Santosh, Shrihari, 2017. "Shrinking the Cross Section," CEPR Discussion Papers 12463, C.E.P.R. Discussion Papers.
    11. PAOLA BRIGHI & STEFANO d'ADDONA & ANTONIO CARLO FRANCESCO DELLA BINA, 2013. "The Determinants of Risk Premia on the Italian Stock Market: Empirical Evidence on Common Factors in Asset Pricing Models," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 42(2), pages 103-133, July.
    12. repec:eee:jfinec:v:126:y:2017:i:3:p:471-489 is not listed on IDEAS
    13. Christian Fieberg & Armin Varmaz & Thorsten Poddig, 2016. "Covariances vs. characteristics: what does explain the cross section of the German stock market returns?," Business Research, Springer;German Academic Association for Business Research, vol. 9(1), pages 27-50, April.

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