Accounting for Asset Pricing Factors

Many accounting numbers appear in standard factor models, including book value, investment, return on equity (ROE), and other profitability measures. However, they do so without a clear explanation of why they indicate investment risk. The papers shows that these numbers are generated under accounting principles that deal with risk, providing an explanation but also a critique of how the numbers enter extant models. That leads to a revision in factor construction. Accounting numbers are codetermined in a double-entry system, a feature that is exploited in packaging the revised factors into a factor model. Rather than entering as the separate, additive factors in extant models, adding to the “factor zoo,” the numbers are combined parsimoniously to capture the information they jointly convey about risk and return in the double-entry system. Empirical tests against extant models confirm