A better three-factor model that explains more anomalies

Abstract

The market factor, an investment factor, and a return-on-assets factor summarize the cross-sectional variation of expected stock returns. The new three-factor model substantially outperforms traditional asset pricing models in explaining anomalies associated with short-term prior returns, financial distress, net stock issues, asset growth, earnings surprises, and valuation ratios. Themodel's performance, combined with its economic intuition based on q-theory, suggests that it can be used to obtain expected return estimates in practice.