The Hou, Xue, and Zhang q-factor model...

Question

BlackTom AI · Accepted Answer

The question asks about the Hou, Xue, and Zhang q-factor model and what it acknowledges or adds to existing frameworks. 
Option a: 'acknowledges that, given the same level of past profits, firms with higher current physical investments to assets have higher expected returns on their stocks.' This statement confuses the emphasis of the q-factor discussion. The Hou–Xue–Zhang model centers on current investment-to-assets and profitability, but the specific comparison in this option uses past profits rather than expected profitability, which misstates the model’s focus and timing.
Option b: 'augments the Fama and French’ three-factor model with new factors.' This is closer to the general purpose of many factor models, but the Hou, Xue, and Zhang q-factor is not simply an augmentation of the Fama–French three-factor model; it is a distinct framework that emphasizes investment and profitability factors, with a particular interpretation of how expected profitability interacts with investment levels.
Option c: 'acknowledges that, given the same level of current physical investments relative to assets, firms with higher expected profits have higher expected returns on their stocks.' This aligns with the core idea of the q-factor literature, which links investment relative to assets and profitability to expected returns, highlighting that profitability signals can explain cross-sectional variation in returns when investment intensity is held constant. The phrasing matches the model’s claim about the relationship between expected profits and returns at a given investment level.
Option d: 'All of the options provided.' Since options a and b contain misstatements or are not accurate characterizations of the Hou–Xue–Zhang q-factor model, this cannot be correct. Only option c accurately captures the intended nuance without overextending or misrepresenting the model.
In summary, option c correctly captures the model’s assertion about the relationship between expected profits, investment intensity, and expected returns, while the other options either misstate the timing or scope of the model or overgeneralize its role relative to the Fama–French framework.

The Hou, Xue, and Zhang q-factor model...

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