Asset Pricing Model with Intangible Capital

Summary (Eng)

Intangible capital has become one of the most important sources of production in the 21st century. It is a critical factor of constructing economic moats which shape the long-run growth potential. This report measures a timevarying firm-level intangible capital. We combine the methods proposed in the past literature. We cumulate sale, general, and administrative expense and research and development expense to measure the intangible asset using a perpetual inventory method. Using this measure of the intangibles, we explore its implications in asset pricing.

We define intangible capital as the sum of organization capital and knowledge capital. We compute their relative values to total book assets (organization/knowledge/intangible capital to book assets) and form double-sort (5x5) portfolios using book-to-market ratio. We find in every book-to-market ratio bin, excess returns, CAPM alphas, Fama and French 3 factor alphas, and Cahart 4 factor alphas are higher among firm with higher organization/knowledge/intangible capital to book assets. It suggests that conventional asset pricing models cannot explain the return variation by the intangibles which implies we can be use the intangibles to enhance the performance of the conventional models.

Hence, we redefine HML using the book-to-market ratio with the intangibles and compare its performance with the conventional HML as defined in Fama and French papers. We recompute book-to-market ratio by including the intangibles on the numerator. We use GRS test statistics and spanning regressions and find the factor models with this new HML have better performance.

This report confirms the importance of the intangible capital and its implication to asset pricing models. As it has become one of the important production factors in the 21st century, we propose we should use its values in asset pricing models as well. QRAFT plans to introduce a new ETF where it utilizes the intangible capital to enhance the conventional value portfolios.