Developing Multifactor Asset Pricing Models Using Firm's Life Cycle

Document Type : Research Paper


1 Ph.D. Candidate, Department of Accounting, Faculty of Administrative Science & Economics, University of Isfahan, Isfahan, Iran.

2 Associate Prof., Department of Accounting, Faculty of Administrative Science & Economics, University of Isfahan, Isfahan, Iran.

3 Assistant Prof., Department of Management, Faculty of Administrative Science & Economics, University of Isfahan, Isfahan, Iran.


Objective: This research is aimed at introducing firms' life cycles as a new and effective factor on stock return and comparing the performance of the new multifactor asset pricing models (augmented by firm's life cycle factor) with corresponding conventional multifactor asset pricing models in explaining stock returns.
Methods: To this end, Dickinson's cash flows pattern has been used to measure the firm's life cycle. A Firm's life cycle factors are constructed based on the difference in average returns of firms in maturity stage and firms in other firm's life cycle stages. Then, this factor waS combined with the conventional multi-factor pricing model, namely the Fama and French three-factor model, Carhart four-factor model, Fama and French five-factor model and Ho, Xue, and Zhang four-factor model. In the following, using time series regression approach, the performance of augmented multifactor asset pricing models and corresponding conventional ones are compared. For this purpose, the accounting and market data from companies listed in Tehran stock exchange and Iran Fara Bourse between the years 2004 and 2018 and the variety of test assets based on different firm's characteristics were used
Results: The results show that augmented multifactor pricing models have a better performance compared to corresponding multifactor pricing models in explaining stock returns and outperformance is more evident when test assets are formed using firm's life cycle compared to test assets formed without the firm's life cycle.
Conclusion: The addition of a firm's life cycle factor improves the performance of conventional multifactor pricing models in explaining stock returns.


Arabzadeh, M., Foroghi, D., Amiri, H. (2018). Explaining Accrual Anomaly Using Multi-factor Pricing Model in Tehran Stock Exchange. Financial Research Journal, 20(3), 305- 326. (in Persian)
Asness, C., Frazzini, A. (2013). The devil in HML’s details. Journal of Portfolio Management 39, 49–68.
Baker, M., Wurgler, J. (2006). Investor sentiment and the cross-section of stock returns. Journal of Finance, 61, 1645–1680.
Ball, R., Gerakos, J., Linnainmaa, J., Nikolaev, V. (2015). Deflating profitability. Journal of Financial Economics, 117(2), 225-248.
Ball, R., Gerakos, J., Linnainmaa, J., Nikolaev, V. (2016). Accruals, cash flow, and operating profitability in the cross section of stock returns. Journal of Financial Economics, 121(1), 28-45.
Banz, R. W. (1981). The relationship between return and market value of common stocks. Journal of financial economics, 9(1), 3-18.
Bozorg Asl, M., & Mosajed Mousavi, M. S. (2016). Fama and French Five-Factor Model with Emphasis on Firm’s Life Cycle Hypothesis. Journal of applied research in financial reporting, 5 (2), 93-118. (in Persian)
Bozorg Asl, M., & Mosajed Mousavi, M. S. (2019). Explanatory Power of Fama and French Three-Factor Model vs Capital Asset Pricing Model Focusing on Firms' Life Cycle. Journal of Empirical Research in Accounting, 8 (2), 321-344. (in Persian)
Bradshaw, M., Richardson, S., Sloan, R. (2006). The relation between corporate financing activities, analysts' forecasts and stock returns. Journal of Accounting and Economics, 42, 53-85.
Campbell, J.Y., Lo, A.W., Lo, A.Y., & Mackinlay, A.C. (1997). The Econometrics of Financial Markets. (2nd ed Edition). Princeton University Press, USA.
Carhart, M. M., (1997). On persistence in mutual fund performance. Journal of Finance 52(1), 57-82.
Chincarini, L. B., Kim, D., & Moneta, F. (2016). The life cycle of beta. Working paper, University of San Francisco, Konkuk University and Queen's University.
Cooper, M. (1999). Filter rules based on price and volume in individual security overreaction. Review of Financial Studies, 12 (4), 901-935.
Dickinson, V. (2011). Cash Flow Patterns as a Proxy for Firm Life Cycle. The Accounting Review, 86(6), 1969-1994.
Doornik, J. (2009). An Object-Oriented Matrix Language Ox 6. London: Timberlake Consultants Press and Oxford:
Doornik, J., & Ooms, M. (2007). Introduction to Ox: An Object-Oriented Matrix Language. Timberlake Consultants Press.
Ecker, F., Francis, J., Kim, I., Olsson, P., & Schipper, K. (2006), A returns-based representation of earnings quality. The Accounting Review 81, 749–780.
Eyvazlu, R., Ghahramani, A., Ajam, A. (2016). Analyzing the Performance of Fama and French Five-factor Model Using GRS Test. Financial Research Journal, 18(4), 691-714. (in Persian)
Fallahpour, S., Mohammadi, Sh., Sabunchi, M. (2018). Analysis of Conditional Capital Asset Pricing Model with Time Variant Beta using Standard Capital Asset Pricing Model. Financial Research Journal, 20(1), 17-32. (in Persian)
Fama, E. F., & French, K. R. (1992). The Cross-Section of Expected Stock Returns. Journal of Finance, 47(2), 427-465.
Fama, E. F., & French, K. R. (1993). Common Risk Factors in the Returns on Stocks and Bonds. Journal of Financial Economics, 33(1), 3-56.
Fama, E. F., & French, K. R. (2018). Choosing Factors. Journal of financial economics, 128(2), 234-253.
Fama, E.F., French, K.R. (2015). A five-factor asset pricing model. Journal of Financial Economics, 116, 1–22.
Gibbons, M., Ross, S. & Shanken, J. (1989). A test of the efficiency of a given portfolio. Econometrica, 57(5), 1121–1152.
Hamers, L., Renders, A., & Vorst, P. (2016). Firm life cycle and stock price crash risk. Working paper, Maastricht University.
Hasan, M. M., Hossain, M., Cheung, A., & Habib, A. (2015). Corporate Life Cycle and Cost of Equity Capital. Journal of Contemporary Accounting & Economics, 11(1), 46-60.
Hasan, M.M., Habib, E. (2017). Firm life cycle and idiosyncratic volatility. International Review of Financial Analysis, 50(March), 164-175.
Hirshleifer, D., Hou, K., & Teoh, S. (2012). The accrual anomaly: Risk or mispricing? Management Science, 58(2), 320–335.
Hou, K., Mo, H., Xue, C., & Zhang, L. (2018). q5. Charles A. Dice Center Working Paper No. 2018-10; Fisher College of Business Working Paper No. 2018-03-010.
Hou, K., Xue, C., Zhang, L., (2015). Digesting anomalies: An investment approach. Review of Financial Studies, 28(3), 650–705.
Karami, Gh., & Akhondi, O. (2016). Corporate Life Cycle and Cost of Equity Capital. Empirical Studies in Financial Accounting, 13(52), 37-60. (in Persian)
Konstantinidi, T. (2019). Firm Life Cycle, Expectation Errors and Future Stock Returns. Sir John Cass Business School, City University of London.
Lewellen, J. (2010). Accounting Anomalies and Fundamental Analysis: An Alternative View. Journal of Accounting and Economics, 50, 455–466.
Lewellen, J., & Nagel, S. (2010). The conditional CAPM does not explain asset-pricing anomalies, Journal of Financial Economics, 82, 289–314.
Lintner, J. (1965). The valuation of risk assets and the selection of risky investments in stock portfolios and capital budgets. Review of Economic Statistics, 47(1), 13-37
Livnat, J., & Zarowin, P. (1990). The incremental information content of cash-flow components. Journal of Accounting and Economics 13(1), 25-46.
Loughran, T., Ritter, J. (1995). The new issues puzzle. Journal of Finance, 50, 23-51.
Miller, E.M. (1977). Risk, uncertainty and divergence of opinion. Journal of Finance 32, 1151–1168.
Mossin, J. (1966). Equilibrium in a capital asset market. Econometrica, 34(4), 768-783.
Ohlson, J. A. (1995). Earnings, book values, and dividends in equity valuation. Contemporary Accounting Research, 11 (2), 661-687.
Penman, S. H., & Zhu, J. (2018). A Fundamental Factor Model. Columbia Business School Research Paper No. 18-76.
Raei, R., & Asima, M. (2018). A Comparison between the Performances of Standard Capital Asset Pricing Model and Capital Asset Pricing Model Based on Symmetric and Asymmetric Conditional Heteroscedasticity in Tehran Stock Exchange. Financial Research Journal, 19(4), 505 – 520. (in Persian)
Richardson, S., Tuna, I., & Wysocki, P. (2010). Accounting Anomalies and Fundamental Analysis: A Review of Recent Research Advances. Journal of Accounting and Economics, 50, 410-454.
Rosenberg, B., Reid, K., & Lanstein, R. (1985). Persuasive evidence of market inefficiency, Journal of Portfolio Management, 11(3), 9-17.
Ross, S. A. (1976). The arbitrage theory of capital asset pricing. Journal of Economic Theory, 13(3), 341–360.
Sharpe, W. E. (1964). Capital asset prices: A theory of market equilibrium under conditions of risk. Journal of Finance, 19(3), 425-442.
Sloan, R. (1996). Do stock prices fully reflect information in accruals and cash flows about future earnings? The Accounting Review, 71(3), 289–315.
Stambaugh, R. F., Yu, J., Yuan, Y., (2012). The short of it: Investor sentiment and anomalies. Journal of Financial Economics, 104 (2), 288-302.
Stattman, D. (1980). Book Values and Stock Returns. The Chicago MBA: A Journal of Selected Papers, 4, 25-45.
Subrahmanyam, A. (2005). Distinguishing between rationales for short-horizon predictability of stock returns. Financial Review, 40 (1), 11-35.
Vorst, P., & Lombardi Yohn, T. (2018). Life Cycle Models and Forecasting Growth and Profitability. The Accounting Review, 93 (6), 357-381.
Wahal, S. (2018). The profitability and investment premium: Pre-1963 evidence. Journal of Financial Economics,
Wang, B. (2019). The cash conversion cycle spread. Journal of Financial Economics, 133(2), 472-497.