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Market Risk Factors

Paper Session

Saturday, Jan. 6, 2018 10:15 AM - 12:15 PM

Loews Philadelphia, Commonwealth Hall D
Hosted By: American Finance Association
  • Chair: Christian Opp, University of Pennsylvania

Empirical Tests of Asset Pricing Models With Individual Assets: Resolving the Errors-in-variables Bias in Risk Premium Estimation

Narasimhan Jegadeesh
,
Emory University
Joonki Noh
,
Case Western Reserve University
Kuntara Pukthuanthong
,
University of Missouri
Richard Roll
,
California Institute of Technology
Junbo Wang
,
Louisiana State University

Abstract

To attenuate an inherent errors-in-variables bias, portfolios are widely employed to test asset pricing models; but portfolios might diversify and mask relevant risk- or return-related features of individual assets. We propose an instrumental variables approach that allows the use of individual assets yet delivers consistent estimates of ex-post risk premiums. This estimator yields unbiased estimates and well-specified tests in small samples. The market risk premium under the CAPM and the liquidity-adjusted CAPM, premiums on risk factors under the Fama-French three- and five-factors models and the Hou, Xue, and Zhang (2015) four-factor model are all insignificant after controlling for asset characteristics.

Where is the Risk in Value? Evidence From a Market-to-Book Decomposition

Andrey Golubov
,
University of Toronto
Theodosia Konstantinidi
,
City University London

Abstract

We study the value premium using a multiples-based market-to-book decomposition of Rhodes-Kropf, Robinson and Viswanathan (2005). The market-to-value component drives all of the value strategy return, while the value-to-book component exhibits no return predictability in either portfolio sorts or firm-level return regressions. Existing results linking market-to-book to long-run consumption risk, cashflow risk, exposure to investment-specific technology shocks, operating leverage, duration, and analysts’ risk ratings derive predominantly from the unpriced value-to-book component. In contrast, results on expectation errors and limits to arbitrage emanate from the market-to-value component. Overall, our evidence casts doubt on most existing risk-based explanations for the value premium.

What Matters to Individual Investors? Evidence from the Horse's Mouth

James Choi
,
Yale University
Adriana Robertson
,
University of Toronto

Abstract

We survey a representative sample of U.S. individuals about how well leading academic theories describe their financial beliefs and decisions. We find substantial support for many factors hypothesized to affect portfolio equity share, particularly background risk, investment horizon, rare disasters, transactional factors, and fixed costs of stock market participation. Individuals tend to believe that past mutual fund performance is a good signal of stock-picking skill, actively managed funds do not suffer from diseconomies of scale, value stocks are safer and do not have higher expected returns, and high-momentum stocks are riskier and do have higher expected returns.
Discussant(s)
Raymond Kan
,
University of Toronto
Juhani T. Linnainmaa
,
University of Southern California
Jianfeng Yu
,
Tsinghua University
JEL Classifications
  • G1 - General Financial Markets