A Long-Run Productivity Risks Driving q-Factor Model

I incorporate the productivity risks into an investment-based q-factor asset pricing model. The productivity risks factors largely summarize the cross-sectional portfolio return, where the time-varying volatility plays an important role. A parsimonious q-factor model driven by productivity risks explains about 90% variation of return of 25 Size/BM portfolios and 75% variation of return of 160 portfolios, which is comparable to the Fama-French multifactor models, the Carhart (1997) four-factor model, and the Hou, Mo, Xue & Zhang (2020) augmented q-factor model. As such, productivity risks significantly affect asset prices and can be one of the potential forces driving investment-based factor models