Aggregation, Capital Heterogeneity, and the Investment CAPM

Abstract

This paper provides a careful treatment of aggregation, and to a lesser extent, capital heterogeneity in the investment CAPM. Firm-level investment returns are constructed from firm-level variables, and then aggregated to the portfolio level to match with portfolio-level stock returns. Current assets form a separate production input besides physical capital. The model fits well the value, momentum, investment, and profitability premiums simultaneously, and partially explains the positive stock-investment return correlations, the procyclical and short-term dynamics of the momentum and profitability premiums, as well as the countercyclical and long-term dynamics of the value and investment premiums. However, the model fails to explain momentum crashes.