Long‐Run Stockholder Consumption Risk and Asset Returns

We provide new evidence on the success of long‐run risks in asset pricing by focusing on the risks borne by stockholders. Exploiting microlevel household consumption data, we show that long‐run stockholder consumption risk better captures cross‐sectional variation in average asset returns than aggregate or nonstockholder consumption risk, and implies more plausible risk aversion estimates. We find that risk aversion around 10 can match observed risk premia for the wealthiest stockholders across sets of test assets that include the 25 Fama and French portfolios, the market portfolio, bond portfolios, and the entire cross‐section of stocks.     

Are good-news firms riskier than bad-news firms?

This paper examines the relative risk of good-news firms, i.e., those with high standardized unexpected earnings (SUE), and bad-news (low SUE) firms using a stochastic discount factor approach. We find that a stochastic discount factor constructed from a set of basis assets helps explain post-earnings-announcement drift (PEAD). The risk exposures on the pricing kernel increase monotonically from the lowest to highest SUE sorted portfolios. Specifically, good-news firms always have higher risk exposures than bad-news firms in both 10 SUE sorted portfolios and 25 size and SUE sorted portfolios. However, the estimated expected risk premium is too small to explain the observed magnitude of returns on the PEAD strategy. Our risk adjustment can explain only about one-fourth of the total magnitude of the average realized return to the PEAD strategy. As a result, the average risk-adjusted returns of earnings momentum strategies are mostly positive and significant. Overall, our results support the view that at least some portion of the returns to the earnings momentum strategies examined represent compensation for bearing increased risk.     

Risk diversification gains from metropolitan housing assets

The study analyzes the roles of metropolitan housing assets in risk diversification by assessing intertemporal hedging demands for multi‐asset portfolios, which include metropolitan houses, REITs, stocks, bonds, and riskless assets. Investors substitute housing assets in high‐population MSAs with those in low‐population cities, and they switch their holdings of housing assets to less risky bonds in the 2007–2008 housing bust. The findings from the multi‐period portfolio choice problem provide evidence for momentum reversal since forward‐looking investors substitute bottom metropolitan housing assets for top ones in the housing boom, and the GTTB index and the lagged REIT price return have negative impacts on various asset returns.     

Consumption, Dividends, and the Cross Section of Equity Returns

We show that aggregate consumption risks embodied in cash flows can account for the puzzling differences in risk premia across book‐to‐market, momentum, and size‐sorted portfolios. The dynamics of aggregate consumption and cash flow growth rates, modeled as a vector autoregression, are used to measure the consumption beta of discounted cash flows. Differences in these cash flow betas account for more than 60% of the cross‐sectional variation in risk premia. The market price for risk in cash flows is highly significant. We argue that cash flow risk is important for interpreting differences in risk compensation across assets.     

The Variation of Economic Risk Premiums in Real Estate Returns

We examine the predictable components of returns on stocks, bonds, and real estate investment trusts (REITs). We employ a multiple-beta asset pricing model and find that there are varying degrees of predictability among stocks, bonds, and REITs. Furthermore, we find that most of the predictability of returns is associated with the economic variables employed in the asset pricing model. The stock market risk premium is highly important in capturing the predictable variation in stock portfolios, and the bond market risk premiums (term and risk structure of interest rates) are important in capturing the predictable variation in bond portfolios. For REITs, however, both the stock and bond market risk premiums capture the predictable variation in returns. REITs have comparable return predictability to stock portfolios. We conclude that there is an important economic risk premium for REITs that are not captured by traditional multiple-beta asset pricing models.     

Systemic Liquidation Risk and the Diversity–Diversification Trade‐Off

This paper proposes a portfolio choice model in which investors are subject to liquidation risk and (endogenously) face higher costs in the event of joint liquidation (as was observed during the crisis of 2008 to 2009). The risk of joint liquidation creates an incentive for investors to choose heterogeneous portfolios and to rationally forgo diversification benefits. Joint liquidation risk is also reflected in asset prices, resulting in (1) assets with high idiosyncratic risk having low expected returns, and (2) assets that display high correlation with the portfolios of (liquidation‐prone) investors having high expected returns.     

Asymmetric Volatility,Skewness, and Downside Risk in Different Asset Classes: Evidence from Futures Markets

This study examines the cross‐sectional variation of futures returns from different asset classes. The monthly returns are positively correlated with downside risk and negatively correlated with coskewness. The asymmetric volatility effect generates negatively skewed returns. Assets with high coskewness and low downside betas provide hedges against market downside risk and offer low returns. The high returns offered by assets with low coskewness and high downside betas are a risk premium for bearing downside risk. The asset pricing model that incorporates downside risk partially explains the futures returns. The results indicate a unified risk perspective to jointly price different asset classes.     

Government Bond Returns,Measurement of Interest Rate Risk,and the Arbitrage Pricing Theory

Empirical tests are reported for Ross' arbitrage pricing theory using monthly data for U.S. Treasury securities during the 1960–1979 period. We find that mean returns on bond portfolios are linearly related to at least two factor loadings. Multivariate test results, however, are not consistent with the APT. Our sample data in the U.S. Treasury securities market are also not consistent with either version of the CAPM. One-month-ahead forecasts of excess returns using factor-generating models are compared with corresponding naive predictions or predictions using the “market model” with various market portfolios.     

Exchange rate risk in the US stock market

Kolari et al. (2008) show that exchange rate risk measured by contemporaneous exchange rate changes is priced in the US stock market. However, by construction, their exchange rate risk factor has a strong correlation with the size factor, and their exchange rate sensitivity portfolios have a strong factor structure. To test whether their results are spurious, we carry out two sets of tests. The first set is motivated by Lewellen et al. (2010), where the second set is motivated by the voluminous literature which suggests that stock returns are heavy-tailed (e.g. Rachev and Mitnik, 2000). Different from Kolari et al. (2008), we find that exchange rate risk measured by contemporaneous exchange rate changes is not priced in the US stock market if we use industry portfolios which do not have a strong factor structure as the testing assets or if we use more robust methods to estimate firm-specific exchange rate sensitivity. Our findings therefore suggest that researchers take a new perspective on exchange rate risk.     

Cross‐sectional Tests of Conditional Asset Pricing Models: Evidence from the German Stock Market

We study the performance of conditional asset pricing models and multifactor models in explaining the German cross‐section of stock returns. We focus on several variables, which (according to previous research) are associated with market expectations on future market excess returns or business cycle conditions. Our results suggest that the empirical performance of the Capital Asset Pricing Model (CAPM) can be improved when allowing for time‐varying parameters of the stochastic discount factor. A conditional CAPM using the term spread explains the returns on our size and book‐to‐market sorted portfolios about as well as the Fama‐French three‐factor model and performs best in terms of the Hansen‐Jagannathan distance. Structural break tests do not necessarily indicate parameter instability of conditional model specifications. Another major finding of the paper is that the Fama‐French model – despite its generally good cross‐sectional performance – is subject to model instability. Unconditional models, however, do a better job than conditional ones at capturing time‐series predictability of the test portfolio returns.     

News and the cross-section of expected corporate bond returns

We study the cross-section of expected corporate bond returns using an inter-temporal CAPM (ICAPM) with three-factors: innovations in future excess bond returns, future real interest rates and future expected inflation. Our test assets are a broad range of corporate bond market index portfolios. We find that two factors – innovations about future inflation and innovations about future real interest rates – explain the cross-section of expected corporate bond returns in our sample. Our model provides an alternative to the ad hoc risk factor models used, for example, in evaluating the performance of bond mutual funds.     

On competition,risk, and hidden assets in the market for bank credit cards

The market for credit cards has been the subject of recent attention and controversy because of ‘high’ profits earned on credit cards and substantial premiums on the resale of credit-card receivables. This paper estimates risk—return profiles for credit-card banks and explores the role of intangible assets in determining resale premiums on credit-card receivables. In addition, the effects on the resale market of securitization and the opportunity cost of acquiring new accounts are analyzed. Using alternative measures of risk and alternative control groups, we find, for the years 1989 to 1995, that credit-card banks earned significantly higher returns on assets but that these returns were associated with greater risk-taking. Analysis of premia for the years 1993 to 1995 suggest that acquiring banks pay higher premia for mid-sized regional accounts than for larger, national portfolios, perhaps because of richer cross-selling opportunities.     

Consumption Volatility Risk

We show that time variation in macroeconomic uncertainty affects asset prices. Consumption volatility is a negatively priced source of risk for a wide variety of test portfolios. At the firm level, exposure to consumption volatility risk predicts future returns, generating a spread across quintile portfolios in excess of 7% annually. This premium is explained by cross‐sectional differences in the sensitivity of dividend volatility to consumption volatility. Stocks with volatile cash flows in uncertain aggregate times require higher expected returns.     

Can tail risk explain size,book‐to‐market,momentum, and idiosyncratic volatility anomalies?

We examine the impact of tail risk on the return dynamics of size, book‐to‐market ratio, momentum and idiosyncratic volatility sorted portfolios. Our time‐series analyses document significant portfolio return exposures to aggregate tail risk. In particular, portfolios that contain small, value, high idiosyncratic volatility and low momentum stocks exhibit negative and statistically significant tail risk betas. Our cross‐sectional analyses at the individual stock level suggest that tail risk helps in explaining the four pricing anomalies, particularly size and idiosyncratic volatility anomalies.     

When Will Mean-Variance Efficient Portfolios Be Well Diversified?

We characterize the conditions under which efficient portfolios put small weights on individual assets. These conditions bound mean returns with measures of average absolute covariability between assets. The bounds clarify the relationship between linear asset pricing models and well-diversified efficient portfolios. We argue that the extreme weightings in sample efficient portfolios are due to the dominance of a single factor in equity returns. This makes it easy to diversify on subsets to reduce residual risk, while weighting the subsets to reduce factor risk simultaneously. The latter involves taking extreme positions. This behavior seems unlikely to be attributable to sampling error.     

A Dynamic Model of Characteristic‐Based Return Predictability

We present a dynamic model that links characteristic‐based return predictability to systematic factors that determine the evolution of firm fundamentals. In the model, an economy‐wide disruption process reallocates profits from existing businesses to new projects and thus generates a source of systematic risk for portfolios of firms sorted on value, profitability, and asset growth. If investors are overconfident about their ability to evaluate the disruption climate, these characteristic‐sorted portfolios exhibit persistent mispricing. The model generates predictions about the conditional predictability of characteristic‐sorted portfolio returns and illustrates how return persistence increases the likelihood of observing characteristic‐based anomalies.     

An alternative measure of the “world market portfolio”: Determinants, efficiency, and information content

The world market portfolio plays an important role in international asset pricing, but is unobservable in practice. We first propose a framework for constructing a market proxy that corresponds to the “market portfolio” of financial theory. We then construct this proxy, analyze its determinants and test its efficiency and explanatory power over the period 1975-2007 with respect to the return generating processes of a broad asset universe. We show that its major determinants are traded assets and that it is not efficient. However, it is significant for explaining individual asset returns over an asset universe that includes stocks, bonds, money markets and commodities. The explanatory information is incremental to what is available in traded asset prices and the significance of this information is robust with respect to diversified portfolios generated by factor analysis and to characteristic-sorted portfolios as well as to various model specifications, including the single-index model, the Fama-French (1992) three factor model for stocks, and various specifications of multi-index models hedged and unhedged for foreign currency risk.     

Expected Returns and Idiosyncratic Risk: Industry-Level Evidence from Russia

We explore a relation between expected returns and idiosyncratic risk in Russia. Investors in the Russian stock market cannot fully diversify their portfolios due to transaction costs, information gathering and processing costs, and shortcomings in investor protection. This implies that investors demand a premium for idiosyncratic risk. We estimate the price of idiosyncratic risk using MIDAS regressions and a cross section of Russian industry portfolios. We find that idiosyncratic risk is economically significant and commands a negative (positive) premium, on average, of 10.0% (8.0) per year before (after) the global financial crisis in 2008. The results remain unaffected after controlling for global pricing factors and return reversal.     

Is there a real estate factor premium?

In this paper, we study the variation of expected returns on five different asset portfolios in a multi-factor model. We found the presence of a real estate factor, in addition to both a stock factor and a bond factor in asset pricing. This suggests that mutual fund managers should seriously consider including real estate assets in their portfolios, since one cannot capture the real estate factor premium without having some kind of real estate exposure. Another result is that the market segmentation found in previous studies disappears in a more general model of asset pricing in which we allow for multi-factors other than the market factor to affect asset returns. This implies that real estate assets can be treated just like other assets as far as mean-variance efficient asset allocations are concerned. We also have some preliminary evidence that equity REITs and the Russell-NCREIF index are driven by the same underlying real estate factor.     

Environmental,social, and governance premium in Chinese stock markets

Financial markets have increasingly adopted the concept of ESG (environmental, social, and governance); this paper studies the evolving effect of corporate ESG performance on the stock returns in China's stock markets. Utilizing the Paris Agreement and China's President Xi's pledge to achieve carbon neutrality by 2060 as ESG shocks, we find that firms with lower ESG scores provide higher stock returns after the announcement of the Paris Agreement. Furthermore, the effect of ESG performance heightens after Xi's pledge. Using sorted portfolios and Fama–French factor models, we find that investors are rewarded for bearing ESG-related risks. Our estimated monthly ESG risk premium is between 0.52% and 0.61%, while state-owned firms with larger market capitalizations and better financial and operational performance tend to have better ESG performance.