Differential risk premiums and the UIP puzzle

We respecify the uncovered interest rate parity (UIP) conditions by inverting the market price of the risk (Sharpe ratio) formula. Our empirical model provides new insight indicating that violations to the UIP stem from the existence of a risk premium in the exchange rates and from observed market return differentials being a noisy statistic of the markets’ expected return differentials in our respecified model. Using an integrated macro‐micro structure framework for expected market return differentials improves our model fit and the validity of UIP.     

Currency futures-spot basis and risk premium

This paper explores the usefulness of currency futures-spot basis in predicting spot rate changes and currency futures returns. We conjecture that the currency risk premium may be an important component of the basis for long-maturity futures contracts, but may not be so for short-maturities. Thus, the basis of long-maturity contracts cannot predict the spot rate changes between now and maturity, rejecting uncovered interest rate parity (UIP), but can predict currency futures returns, which are solely determined by the risk premium. Conversely, the basis of the short-maturity contracts can predict the spot rate changes between now and maturity, validating the UIP, but cannot predict currency futures returns. Empirical tests support these conjectures for the Japanese, British, Swiss, and German currencies over the last two decades. The results are also consistent with Longstaff [Longstaff, F., 2000. The term structure of very short-term rates: new evidence for the Expectation Hypothesis. Journal of Financial Economics 58, 397–415], who shows that the Expectations Hypothesis holds at the very short end of the term structure of interest rates.     

The role of covered interest parity in explaining the forward premium anomaly within a nonlinear panel framework

This paper investigates the dynamic properties of uncovered interest parity (UIP) depending on deviations from covered interest parity (CIP) in a nonlinear panel framework. By employing a panel smooth transition regression model, the threshold level of the CIP deviation in which UIP tends to hold is found to be outside the band of inaction where deviations from CIP would fail to be arbitraged away. This paper shows how reversals of UIP observed during the global financial crisis can be, to some extent, accounted for by funding liquidity constraints. Simulation experiments also suggest that the data-generating process from the nonlinear panel model can produce data consistent with the failure of UIP.     

Resolving the Puzzling Intertemporal Relation between the Market Risk Premium and Conditional Market Variance: A Two-Factor Approach

The existing empirical literature fails to agree on the nature of the intertemporal relation between risk and return. This paper attempts to resolve the issue by estimating a conditional two-factor model motivated by Merton's intertemporal capital asset pricing model. When long-term government bond returns are included as a second factor, the partial relation between the market risk premium and conditional market variance is found to be positive and significant. The paper also helps explain the convoluted empirical relation between the market risk premium, conditional market variance, and the nominal risk-free rate previously reported in the literature.     

The pricing of systematic liquidity risk: Empirical evidence from the US stock market

In this study, we examine whether aggregate market liquidity risk is priced in the US stock market. We define a bivariate Garch (1,1)-in-mean specification for the market portfolio excess returns and the changes in the standardized number of shares in the S&P 500 Index, the aggregate market liquidity proxy. The findings, based on monthly data, suggest that systematic liquidity risk is priced in the US over the period January 1973–December 1997. The liquidity premium represents a non-negligible, negative and time-varying component of the total market risk premium whose magnitude is not influenced by the October’87 Crash.     

基于面板模型的中国国债风险溢价实证研究

该研究采用面板模型实证分析了2003年12月至2008年4月上海证券交易所债券市场国债风险溢价与利率期限结构及宏观经济变量的关系。实证结果显示，上期利率期限结构曲线越陡峭，当期国债风险溢价越高；上期通货膨胀水平越高，当期国债风险溢价越高，而再延长一期滞后期，会发现滞后第二期的通货膨胀水平与当期国债风险溢价存在显著负关系；货币供应同比增速增加时，国债风险溢价水平降低。     

Is the Market Portfolio a Dynamic Factor? Evidence from Individual Stock Returns

This paper uses a factor model to test whether the market portfolio is a dynamic factor in the sense that individual stock returns contain a premium linked to the conditional risk of the market portfolio. The market conditional risk is based on a decomposition of the market variance into a time-varying trend component and a transitory component. The evidence shows that the conditional market premium is rising when the permanent trend rises relative to the conditional variance. The evidence for individual stock returns supports the notion that the market portfolio is a dynamic factor. Individual stock return autocorrelations are fully explained by the time variation in the market premium. The risk premia attributed to static factors are statistically insignificant.     

The intertemporal relationship between market return and variance: an Australian perspective

In this paper we investigate the intertemporal relationship between the market risk premium and its conditional variance in an Australian setting. Using a bivariate EGARCH‐M model combined with the dynamic conditional correlation (DCC) framework as proposed by Engle (2000), we find evidence of a positive relationship between the market risk premium and its variance and evidence of two distinct interest rate effects. Furthermore, while the bond market's own variance is not priced by investors, we find that the covariance between equity and bond markets is a significant risk factor that is priced in the market.     

THIN TRADING AND THE ESTIMATION OF BETAS: THE EFFICACY OF ALTERNATIVE TECHNIQUES

Infrequent trading induces biased estimates of the beta risk coefficient. This paper reports on the efficacy of approaches that seek to correct for this bias and documents the extent of thin trading among New Zealand securities. Parameter estimates free of the thin-trading bias are obtained. These are compared with estimates obtained using ordinary least squares (OLS) applied in the conventional manner to nonsynchronous data, with and without bias-correcting procedures. OLS beta estimates are found to be less biased, more efficient, and as consistent when compared with Dimson or Scholes-Williams estimators. Lower beta estimates are associated with lower trading frequencies.     

Return Distributions and Improved Tests of Asset Pricing Models

We compare and contrast some existing ordinary least squares(OLS)- and generalized method of moments (GMM)-based tests ofasset pricing models with a new more general test. This newtest is valid under the assumption that returns are ellipticallydistributed, a necessary and sufficient assumption of the linearcapital asset pricing model (CAPM). This new test fails to rejectthe CAPM on a dataset of stocks sorted by market valuations,whereas similar tests constructed from OLS and GMM estimationmethods reject the linear CAPM. We also find that outliers reducethe OLS-estimated mispricing of the linear CAPM on monthly returnssorted by previous performance, that is, momentum. Monte Carloevidence supports superior size and power properties of thenew test relative to OLS- and GMM-based tests.     

The joint cross-sectional variation of equity returns and volatilities

This paper analyzes the determinants of the simultaneous cross-sectional variation of return and volatility risk premia. Independently of the model specification employed, the estimated risk premium associated with the default premium beta is always positive and statistically different from zero. Moreover, the risk premium of the market volatility risk premium beta is negative and statistically significant. However, both risk factors are priced economically and statistically differently in the volatility and return segments of the market. On average, common factors in both segments explain 90% of the variability of volatility risk premium portfolios, but only 65% of the variability of equity return portfolios.     

Does the equity premium puzzle persist during financial crisis? The case of the French equity market

This paper examines the effects of the financial crisis that began in 2008 on the equity premium of 6 French sector indices. Since the systematic risk coefficient beta remains the most common explanatory element of risk premium in most asset pricing models, we investigate the impact of the crisis on the time-varying beta of the six sector indices cited. We selected daily data from January 2003 to December 2012 and we applied the bivariate MA-GARCH model (BEKK) to estimate time-varying betas for the sector indices. The crisis was marked by increased volatility of the sector indices and the market. This rise in volatility led to an increase in the systematic risk coefficient during the crisis and first post-crisis period for all the major indices. The results are intuitive and corroborate findings in the empirical literature. The increase of the time-varying beta is considered by investors as an additional risk. Therefore, as expected, investors tend to increase their equity premiums to b ear the impact of financial crisis.     

A conditional regime switching CAPM

The standard Capital Asset Pricing Model (CAPM) is simple, intuitive, and grounded in sound economic theory. Yet, almost half a century's worth of empirical testing has so far failed to demonstrate its relevance. One major reason given for the CAPM's empirical failure is that beta is not the sole measure of systematic risk. In other words, the standard CAPM does not hold. Another important explanation is that the CAPM may hold conditionally rather than unconditionally. The standard CAPM fails to explain the cross-section of returns because it ignores the fact that both the risk and the price of risk are time-varying. The search for conditional models has led researchers to either disregard the theory behind the CAPM or to use statistical procedures that are too complex to be replicated by other researchers and practitioners. In this paper we propose a conditional model that is compatible with the standard CAPM while remaining simple and accessible to both researchers and practitioners. Beta and the risk premium are assumed to be time-varying, with the latter being associated with bull and bear states. We find strong support for the conditional CAPM with beta explaining both bull and bear markets. While the bear market ex-post risk premium is negative, the weighted average risk premium is positive and highly significant.     

Comoment risk and stock returns

We estimate investable comoment equity risk premiums for the US markets. The stock's contribution to the asymmetry and the fat tails of the market portfolio's payoff are priced into a coskewness premium and a cokurtosis premium. We construct zero-investment strategies that are long and short in coskewness and cokurtosis equity risks; we infer from the spread the returns attached to a unit exposure to US equity coskewness and cokurtosis. The coskewness and cokurtosis premiums present positive monthly average returns of 0.27% and 0.14% from January 1959 to December 2011. Comoment risks appear to be significantly priced within the US stock market and display significant explanatory power regarding the US size and book-to-market effects. The premiums do not subsume, but rather complement the empirical capital asset pricing model. Our analysis relies on data collected from CRSP (Chicago Research Center for Security Prices) over December 1955 to December 2011. To our knowledge, the paper is the first to propose investable higher-moment risk factors over such an extensive time period.     

Time Varying Market Leverage, the Market Risk Premium and the Cost of Capital

This paper shows that, when as usual the market portfolio is proxied by a share portfolio, then the conventional Ibbotson (1999) estimator of the market risk premium violates Miller–Modigliani (1958 and 1963) propositions II and III. A new estimator of the market risk premium is proposed which is free of these defects. In addition, across the range of market leverages experienced in the US in the period 1952–1997, it generates estimates of the market risk premium that differ from those generated by the Ibbotson methodology by up to 2.5 percentage points, and weighted average costs of capital for firms that differ by up to 2.6 percentage points.     

A liquidity-augmented capital asset pricing model

Using a new measure of liquidity, this paper documents a significant liquidity premium robust to the CAPM and the Fama–French three-factor model and shows that liquidity is an important source of priced risk. A two-factor (market and liquidity) model well explains the cross-section of stock returns, describing the liquidity premium, subsuming documented anomalies associated with size, long-term contrarian investment, and fundamental (cashflow, earnings, and dividend) to price ratios. In particular, the two-factor model accounts for the book-to-market effect, which the Fama–French three-factor model fails to explain.     

Currency returns, market regimes and behavioral biases

Covered interest rate parity assumes that there is no risk premium on the hedged returns on currencies. However, empirical evidence indicates that risk premiums are not identically zero, and this is referred to as the forward premium puzzle. We show that there exist market regimes, within which behavioral biases affect decisions, and a type of parity holds within regimes. The foreign exchange market switches between regimes where there is a premium. This paper presents various tests for the hypotheses of currency regimes and regime dependent risk premiums. Based on the existence of regimes, a diversified currency portfolio is created with a mean-variance criterion. Using the Federal Exchange Rate Index as a proxy for the currency benchmark and the U.S. T-Bill as the risk free asset, the similarity between the benchmarks and the implied equilibrium hedged and unhedged portfolios provides evidence for regimes and decision bias. Within each regime interest rate parity is appropriate for modeling currency returns.     

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.     

Habit persistence: Explaining cross-sectional variation in returns and time-varying expected returns

This paper uses an iterated GMM approach to estimate and test the consumption based habit persistence model of Campbell and Cochrane [Campbell, J.Y., Cochrane, J.H., 1999. By force of habit: A consumption-based explanation of aggregate stock market behavior. Journal of Political Economy 107, 205–251] on the US stock market. The empirical evidence shows that the model is able to explain the size premium, but fails to explain the value premium. Further, the state variable of the model – the surplus consumption ratio – explains counter-cyclical time-varying expected returns on stocks. The model also produces plausible low real risk-free rates despite high relative risk aversion.     

How Does Information Quality Affect Stock Returns?

Using a simple dynamic asset pricing model, this paper investigates the relationship between the precision of public information about economic growth and stock market returns. After fully characterizing expected returns and conditional volatility, I show that (i) higher precision of signals tends to increase the risk premium, (ii) when signals are imprecise the equity premium is bounded above independently of investors' risk aversion, (iii) return volatility is U-shaped with respect to investors' risk aversion, and (iv) the relationship between conditional expected returns and conditional variance is ambiguous.