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Pricing the hedging factor in the cross-section of stock returns
Institution:1. College of Business and Economics, California State University, East Bay, Hayward, CA 94588, USA;2. Department of Business, Penn State University Abington, Abington, PA 19001, USA;3. Federal Government of Brazil, Ministry of the Economy, Brazil;1. College of Business and Economics, Boise State University, 1910 University Drive, Boise, ID 83725-1610, United States;2. Department of Economics and Finance, University of Dayton, Miriam Hall 502, 300 College Park, Dayton, OH 45469, United States;1. Gabelli School of Business, Fordham University, 45 Columbus Avenue, Room 510, New York, NY 10023, USA;2. Montpellier Business School, 2300 Avenue des Moulins, 34080 Montpellier, France;3. Poznan University of Economics and Business, Institute of Finance, Department of Investment and Financial Markets, al. Niepodległości 10, 61-875 Poznań, Poland;4. University of Montpellier, Montpellier Research in Management, Montpellier, France;1. PBC School of Finance, Tsinghua University, 43 Chengfu Road, Beijing 100083, PR China;2. China Finance 40 Forum, Beijing, PR China;3. Nottingham University Business School, Jubilee Campus, University of Nottingham, Nottingham NG8 1BB, United Kingdom;1. Institute of Mathematical Sciences, Faculty of Science, University of Malaya, 50603 Lembah Pantai, Kuala Lumpur, Malaysia;2. Department of Mathematical and Actuarial Sciences, Lee Kong Chian Faculty of Engineering and Science, Universiti Tunku Abdul Rahman, Malaysia
Abstract:We investigate the role of investors’ net hedging strategy (factor) in predicting stock returns and pricing the cross-section of individual stocks and equity portfolios. We estimate stock exposure to changes in the hedging factor and show that the hedging premium is driven by outperformance of stocks with large positive net hedging betas, which explains their higher average returns. We find the positive hedging premium indicates risk-averse investors demand extra compensation to hold stocks with higher equity risk premiums, and they are themselves willing to pay higher prices for stocks with positive hedging betas.
Keywords:Intertemporal capital asset pricing model  Fama-French three-factor model  Hedging risk factor
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