Profitability Premium Research Articles

The impact of brand equity on profit premium in an equilibrium framework

AbstractRecent research extends the estimation and analysis of structural demand and supply models to consider the concepts of brand equity and brand value and their role in product investment decisions. In this paper, we analyze data from the Dutch market for new cars to show that differences in brand equity may also entail significant differences in marginal costs. Next, we illustrate that ignoring the role of brand equity in marginal costs, as the existing literature has, ignores the possibility that investments in brand equity may actually reduce the marginal profits for the offering. This can change investment incentives and produce different market structures.

Anatomy of recent value premium's travails

The recent underperformance of the value effect has prompted investors to question whether the value effect has lost its potency. In the Chinese A-share market where the value effect has vanished like in the U.S. market, there is a negative relationship between value and composite profitability, a metric comprising profitability levels and earnings growth. This steadily intensifying relationship, coupled with the positive and stable composite profitability premium, causes the weakening effect of composite profitability on the value premium to grow more pronounced over time. This substantial dampening effect, the primary driver of the time variations of the value premium, is precisely why the value premium, although impressive in its early stages, remains ineffective over the nearly two decades of the entire sample period. When the interference of composite profitability is removed, the value effect experiences a significant resurgence, boosting returns to an astonishing 1.97% per month.

Mispricing and Profitability Premium in the U.S. Stock Market

This paper examines the effect of profitability premium in the U.S. stock market through a variety of profitability measures. The empirical results show that there is a positive profitability premium, which comes mainly from short legs rather than long legs. Firms with high profitability generate significantly higher future stock returns than those with low profitability, and the profitability premium is particularly prominent among firms with large capitalization and high growth. The profitability strategy tends to be a growth strategy for a large stock, and behavioral mispricing fails to explain the phenomenon of the profitability premium in the U.S. stock market.

Market Power, Technology Shocks, and the Profitability Premium

Market Power, Technology Shocks, and the Profitability Premium

Operating Hedge and Gross Profitability Premium

ABSTRACTWe show theoretically that variable production costs reduce systematic risk of firms' cash flows if capital and variable inputs are complementary in firms' production and input prices are procyclical. In our dynamic model, this operating hedge effect is weaker for more profitable firms, giving rise to a gross profitability premium. Moreover, gross profitability and value factors are distinct and negatively correlated, and their premia are not captured by the capital asset pricing model (CAPM). We estimate the model by simulated method of moments, and find that its main implications for stock returns and cash flow dynamics are quantitatively consistent with the data.

Why does operating profitability predict returns? New evidence on risk versus mispricing explanations

AbstractThis study develops new evidence on risk versus mispricing explanations of the well‐known profitability premium. First, we examine whether exposure to expected downside risk is a plausible explanation. We find that high profitability is associated with both lower ex ante and ex post probabilities of future price crashes. Thus, less profitable firms exhibit greater downside risk than highly profitable firms, making a downside risk explanation implausible. Although this fact is overlooked by the market in general, it is anticipated by options traders; we find that put options of low profitability firms are relatively more expensive. Simultaneously, these firms do not exhibit greater probability of jumps, indicating that volatility(risk)‐based explanations for the profitability premium are unlikely to be descriptive. Second, we find that the sticky‐expectations model of Bouchaud et al. (2019, The Journal of Finance, 74, 639–674) only partially explains the profitability premium. While on average, analysts' forecast revisions correct in the same direction as recent profitability, the profitability premium still exhibits a strong relationship to the non‐sticky component of analysts' forecast revisions. Third, institutional investors trade profitability‐based signals but do so with a delay, likely contributing to the premium. Overall, our evidence favours the explanation that the profitability premium is related to investor mispricing of potential downside risk and provides greater clarity on recent findings in the literature.

Does the investment-profitability correlation affect the factor premiums? Evidence from China

We investigate whether the investment-profitability correlation affects the investment and profitability premiums in the U.S. and Chinese markets. By replicating the results of Kilic, Yang and Zhang (2022), we confirm that the factor premiums are lower when the investment-profitability correlation is high in both markets. However, unlike the U.S. market, mitigating the correlation effect does not resurrect the insignificant investment premium in China. In contrast, the profitability factor earns robust returns under different specifications.

Financial openness and profitability premium: Causal evidence from the Shanghai‐Hong Kong Stock Connect

AbstractThis study explores the impact of capital market openness on the profitability premium by using the Shanghai‐Hong Kong Stock Connect (SHKSC) programme as an exogenous shock. The empirical results show that (1) we can basically rule out the mispricing mechanism driving the significant profitability premium in China; (2) following SHKSC, the expected stock returns increase more across less profitable firms, and the less profitable firms have more increases in illiquidity, capital structure and information disclosure quality; and (3) the results are still robust after using propensity score matching analysis, deleting the highly volatile periods and conducting a firm‐level test with the triple‐differencing design.

How Targeting the Size, Value, and Profitability Premiums Can Improve Retirement Outcomes

How Targeting the Size, Value, and Profitability Premiums Can Improve Retirement Outcomes

Changes in firm profitability, heterogeneous investor beliefs, and stock returns

In this study, we show that changes in profitability predict a firm's stock returns and future profitability. We construct three horizon-based profitability changes, including short-, medium-, and long-term changes. We find that the predictive information for short-term changes in profitability is not subsumed by the profitability level in the Chinese stock market. We also find that short-term profitability changes generate an asymmetrical premium across different market states. Furthermore, we find that the beta anomaly is embedded in the premium generated by a short-term change in profitability. In addition, we explore the underlying mechanisms of the profitability premium and propose a heterogeneous investor belief channel to explain the profitability premium. We find that risk-based q-theory also helps explain the profitability premium. Therefore, the profitability premium comes from a mixed source and cannot be entirely explained by a single theory.

Marketing Equity using a Five-Factor Asset Pricing Model in ASEAN Countries

This research examines the impact of market risk premium, size, book-to-market equity, profitability, and investment as risk factors on stock return. Portfolios are formed to develop the left-hand side and right-hand side portfolios. The objective of this paper is to assess the performance of the equity market and to enhance the generalizability of the five-factor model. A statistical analysis is applied to estimate the asset pricing model to assess their performance in the Association of Southeast Asian Nations (ASEAN) equity market. The researchers found that there were value premiums in the average stock returns in all the countries except Malaysia. Traces of profitability premium can be observed in Malaysia, Thailand and Indonesia. However, there was no evidence of investment premiums in any of the countries. The study examines whether the asset pricing models capture the value, profitability and investment patterns in the capital market. The five-factor model performs better than the three-factor model in explaining the average excess returns of the size–BM (book-to-market) and size–profitability portfolios. However, the five-factor model fares poorly in explaining the average excess returns of the size–investment portfolios.

The cross-section of investment and profitability: Implications for asset pricing

Asset pricing predictions from the investment CAPM depend on the cross-sectional relation between investment and profitability. In samples of U.S. stocks featuring high cross-sectional investment-profitability correlation, both investment and profitability premiums are weak. Consistent with the conditional predictions from the investment CAPM, triple sorts on size, investment, and profitability as in Hou et al. (2015)’s q-factors resurrect the premiums in the high-correlation samples. We find similar results using cash-based profitability, consistent with the dynamic investment CAPM. Our work has important implications for constructing asset pricing factors and interpreting out-of-sample asset pricing test results, in particular the insignificance of historical investment and profitability premiums.

Technical trading rules' profitability and dynamic risk premiums of cryptocurrency exchange rates

PurposeThe study considers time-varying risk premium in investigating the capability of technical analysis (TA) to predict and outperform a buy–hold strategy in Bitcoin exchange rate returns.Design/methodology/approachThe study tests the technical trading rule of fixed moving average (FMA) on daily actual and equilibrium returns of Bitcoin exchange rates. The equilibrium returns are computed using dynamic CAPM in conjunction with a VAR-MGARCH (1, 1) system. The empirical evaluation of the study uses a case study of four Bitcoin exchange rates (BTC/AUD, BTC/EUR, BTC/JPY and BTC/ZAR) for the period 19 June 2010 to 30 October 2020.FindingsThe findings are consistent with related studies in conventional foreign exchange markets that find TA to be profitable, especially in emerging markets. Nevertheless, the consideration of risk premium has the effect of reducing the abnormal returns. Also, further robust tests reveal that Bitcoin returns possess a momentum effect which prompts further study in efficient market hypothesis research.Practical implicationsThe empirical findings of this study should benefit portfolio managers and active investors on the strength of TA to predict returns in a speculative market like the Bitcoin exchange rate market.Originality/valueThe study takes cognisance that cryptocurrency trading is speculative in nature which renders it a good candidate for TA methods. While there are studies that have explored the value of TA in Bitcoin exchange rates, these studies fail to incorporate the effects of time-varying risk premiums, the strength and focus of the current paper.

ECONOMETRIC ASSESSMENT OF RISK PREMIUMS IN THE RUSSIAN STOCK MARKET

Reasonable investing is impossible without assessing risk premiums. In finance, the following set of risk premiums is commonly used: market risk premium, size premium, value premium, profitability premium, investments premium and momentum premium. In addition, in the context of the current trend in the development of the global financial system towards responsible investment, a responsibility premium can be distinguished. The importance of studying responsibility premium in the Russian stock market is due to the desire of the Bank of Russia to transform it towards greater responsibility and introduce ESG factors into the activities of institutional and retail investors. The purpose of this article is to identify risk premiums that are statistically significant for the Russian stock market. The study period: from 01.12.2011 to 31.12.2020. As a result of applying the two-step econometric Fama-MacBeth procedure, which includes time series regression and panel regression, it is concluded that market risk premium and momentum premium (at the level of 1%), as well as profitability premium (at the level of 5%) showed statistical significance during the period under consideration. In addition, these premiums are positive. The remaining premiums, including responsibility premium, did not show statistical significance. According to the results, only three premiums should be used when constructing asset pricing model in the Russian stock market. This result has practical implications in the context of investing in Russian stocks. An independent result is the assessment of responsibility premium for Russian shares. The statistical insignificance of responsibility premium allows us to make a reasonable assumption that the introduction of ESG factors into the activities of Russian institutional and retail investors will not reduce the effectiveness of their investment decisions.

Leverage and the Profitability Premium

Leverage and the Profitability Premium

Operating Hedge and Gross Profitability Premium

Operating Hedge and Gross Profitability Premium

The Oligopoly Lucas Tree

Abstract This paper proposes a novel quantitative framework with endogenous strategic competition in heterogeneous concentrated industries. Oligopolies compete strategically for profit margins in repeated games, trading off the benefits of future cooperation against those of reaping higher short-run profits by undercutting their rivals. Cross-industry dispersions in market leadership persistence and cash flow loadings on expected growth, as primitive characteristics, simultaneously determine the relationships among profitability, book-to-market ratios, and systematic risk exposures, thereby quantitatively rationalizing the gross profitability and value premium across industries and, importantly, their interactions. Controlling for the book-to-market ratio (gross profitability) makes the gross profitability (value) premium more pronounced. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

GROSS PROFITABILITY AND 52-WEEK HIGH PRICE

The purpose of the study is to measure the conjoint effect of investment strategy based on gross profitability and 52-week high in Borsa İstanbul for the period 2007-2016. The strategy suggests the investors can profit when they take a long position on stocks with high gross profitability and 52-week high, and short position on stocks with low gross profitability and 52-week high. The portfolio method is used in the analysis. The portfolios sorted on 52-week high provide premium but statistically insignificant whereas gross profitability premium is found positively significant. Besides that, the seasonality of profitability returns is observed, though it is weak. When the strategies are analyzed together, the findings exhibit no superior performance of combined strategy despite of positive premium. It may stem from 52-week high effect that is employed as an alternative measure of momentum. This study exhibits a new evidence in the context of the joint effect of strategies. It’s considered that forthcoming researches might focus on the combined performances of the other strategies also by employing alternative measures.

Symbolic Awards in Buyer–Supplier Relations

Problem definition: Giving out a symbolic “supplier of the year” or “outstanding supplier” award can be beneficial for a buyer as it may incentivize a supplier to exert higher efforts. However, when a good supplier is scarce, the award announces which supplier is particularly good and may increase the cost of building and maintaining the relationship. This paper studies both positive and negative effects of a symbolic award and offers explanations on underlying behavioral mechanisms. Academic/practical relevance: We show that symbolic awards can effectively incentivize suppliers to provide high effort, improving a buyer’s bottom line. This is particularly relevant in cases in which certain aspects of a buyer–supplier relationship are not contractible and suppliers have discretion over the quality provided. The award format significantly influences the award’s effectiveness. Methodology: We develop a game-theoretical model that captures a supplier’s utility for the award in a competitive setting and test the predictions of the model with laboratory experiments. Results: Our experimental results confirm that private symbolic awards have motivating effects and lead to higher buyer profits. When the awards are public, this profit premium diminishes as buyers pay higher prices to get the good suppliers. When the buyer is given the option to make the award public or private, buyers prefer that awards are public over private, anticipating a negative supplier response to their choice of the private award format. Managerial implications: Expressing praise or gratitude for a supplier’s efforts can be highly beneficial for a buyer. However, when there is scarcity of good suppliers, buyers should expect increased competition and accompany the award with efforts to preserve the relationship. Finally, if buyers choose to offer a distinctive award format, private recognitions may be perceived as greedy or self-interested and backfire.

Investor Sentiments and Fama–French Five-Factor Premia

This study provides new insights to predict the excess return of a security. As if factor premia are getting influenced by the sentiments that means sentiments are ultimately affecting the excess return of a security. To meet the objective, a composite index developed by Baker and Wurgler is used as sentiment proxy. Monthly data are used from July 1965 to September 2015 in U.S. context. Granger casualty, Vector Autoregression (VAR), and Fama–Macbeth regression are applied to get the results. Results show that investor sentiments significantly drive the Fama factors’ premia: size premium and profitability premium. Sentiments also contain some information to explain the investment premia but fail to explain the market risk premium and value premium. Furthermore, results suggest that sentiments increase the explanatory power of model measured by R square. In short, this study suggests that investor sentiments play a role in explaining the Fama–French five-factor premia.