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Firm Fundamental Cycle and Cross-Section of Stock Returns

Last Updated on 10 February, 2024 by Rejaul Karim

Experience insightful exploration into the complex relationship between company fundamentals and stock returns in “Firm Fundamental Cycle and Cross-Section of Stock Returns.” This 77-page study by Yufeng Han, Zhaodan Huang, Weidong Tian, and Guofu Zhou takes you into the core of firm fundamental indexes, providing a comprehensive look at a company’s varied business dealings.

The study reveals connections between company fundamental cycles and larger economic cycles, highlighting how momentum and long-term reversal coincide with different stages of these cycles. The study introduces a pioneering fundamental-based factor, smoothly incorporated into the Fama and French five-factor model, which significantly boosts the model’s explanatory capabilities across 247 different anomalies.

Engage with this research to understand the significant impact of economic forces on stock market anomalies, moving beyond traditional views of behavioral biases.

Abstract Of Paper

We construct firm fundamental indexes to summarize a firm’s broad range of business activities, and show that firms experience fundamental cycles similar to the business cycles of the aggregate economy. We find that momentum and long-term reversal are manifestation of the different stages of firm fundamental cycles. In addition, a fundamental-based factor explains factor momentum, and adding it into the Fama and French (2015) five-factor model, raises the fraction of anomalies explained from 37% to 80% out of a comprehensive set of 247. Our evidence shows that it is economic forces rather than behavioral biases, that are the main drivers of anomalies.

Original paper – Download PDF

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Author

Yufeng Han
University of North Carolina (UNC) at Charlotte – Finance

Zhaodan Huang
Utica University

Weidong Tian
University of North Carolina (UNC) at Charlotte – The Belk College of Business Administration

Guofu Zhou
Washington University in St. Louis – John M. Olin Business School

Conclusion

Han, Huang, Tian, and Zhou dissect the intricacies of firm fundamental cycles, revealing a profound connection to stock returns. Their innovative construction of firm fundamental indexes unveils cycles mirroring the broader economic landscape. Astutely, they link momentum and long-term reversal to distinct phases in these fundamental cycles.

In a groundbreaking move, a fundamental-based factor emerges, shedding light on factor momentum. Integration into the Fama and French five-factor model propels explanatory power, soaring from 37% to an impressive 80% across 247 anomalies.

This research underscores the dominance of economic forces over behavioral biases, offering a paradigm shift in understanding stock anomalies. The firm fundamental cycle proves to be a guiding force, transcending traditional perspectives and enriching anomaly explanations.

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FAQ

Q1: What is the main focus of the research conducted by Yufeng Han, Zhaodan Huang, Weidong Tian, and Guofu Zhou in “Firm Fundamental Cycle and Cross-Section of Stock Returns”?

A1: The research focuses on constructing firm fundamental indexes to understand a company’s diverse business activities and how these relate to fundamental cycles. It explores the connections between firm fundamental cycles and larger economic cycles, specifically investigating the manifestation of momentum and long-term reversal at different stages of these cycles.

Q2: How does the research contribute to the understanding of stock market anomalies, and what is the significance of the introduced fundamental-based factor?

A2: The research introduces a fundamental-based factor that significantly enhances the explanatory power of the Fama and French five-factor model. This factor explains factor momentum, and its incorporation into the model increases the fraction of anomalies explained from 37% to an impressive 80% across 247 different anomalies. The findings suggest that economic forces, rather than behavioral biases, play a crucial role in driving anomalies.

Q3: What is the key takeaway regarding the impact of firm fundamental cycles on stock returns, and how does this research challenge traditional views?

A3: The research reveals a profound connection between firm fundamental cycles and stock returns, challenging traditional views by emphasizing the dominance of economic forces over behavioral biases in driving anomalies. The innovative construction of firm fundamental indexes and the identification of distinct phases in fundamental cycles associated with momentum and long-term reversal contribute to a deeper understanding of the complex relationship between company fundamentals and stock market dynamics.

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