Which characteristics provide incremental information for expected returns. Many option studies have estimated a negative price of risk for market. Consumption risk and the cross section of expected returns jonathan a. Stock market crosssectional skewness and business cycle. The model explains well the cross section of stock returns in addition to the excess market return. The conditional beta and the crosssection of expected. Hence, both shareholders and key talent have a claim to its cash ows. Papers are invited for submission on this broad theme, including. The crosssection of expected stock returns eugene f. Fama and french 1992 find that two variables, market equity me and the ratio of book equity to market equity beme capture much of the cross section of average stock returns. Organization capital and the crosssection of expected returns andrea l. Predicting stock returns using firm characteristics. The conditional capm and the cross sectionof expected returns ravi jagannathan and zhenyuwang abstract most empirical studies of the static capm assume that betas remain constant over time and that the return on the valueweighted portfolio of all stocks is a proxy for the return on aggregate wealth.
Media coverage and the crosssection of stock returns lily fang and joel peress forthcoming in the journal of finance abstract by reaching a broad population of investors, mass media can alleviate informational frictions and. If aggregate volatility is a risk factor that is orthogonal to existing risk factors, the sensitivity of stocks. Stock returns jeremiah green assistant professor smeal college of business, pennsylvania state university paper with john hand and frank zhang. How average returns change across different stock or portfolios.
November 3, 2011 abstract in this paper i develop and empirically test a model that highlights how the correlation between cash. The cross section of volatility and expected returns. Singapore management university institutional knowledge at. A voluminous literature has studied the cross section of stock returns, but papers that examine the cross section of option returns are sparse. Abstract two easily measured variables, size and book. Ball 1978 argues that ep is a catchall proxy for unnamed factors in expected returns. Cps by sorting on characteristics positively associated with expected returns. Whatever the underlying economic causes, our main result is straightfor ward. On the crosssectional relation between expected returns. Given this extensive data mining, it does not make sense to use the usual criteria for establishing.
Financial intermediaries and the crosssection of asset. The conditional capm and the crosssection of expected. Previous studies on option returns have focused on index options e. In other words, knowing a portfolio pe ratio is more informative for forecasting expected returns than knowing the hml factor loading is. The interest rate factor is priced and seems to drive most of the explanatory power of the model. The authors thank ariel zucker and daniel green for outstanding research assistance. First, using the cross section of returns allows us to create a useful hedging, or mimicking factor portfolio for aggregate volatility risk. We want to both determine whether the volatility of the market is a priced risk factor and estimate the price of aggregate volatility risk. Stocks as lotteries and the crosssection of expected returns turan g. Two easily measured variables, size and booktomarket equity, combine to capture the crosssectional variation in average stock returns associated with market b. Forecast dispersion and the crosssection of expected returns timothy c. Earnings, retained earnings, and booktomarket in the. Parker princeton university and national bureau of economic research christian julliard princeton university this paper evaluates the central insight of the consumption capital asset pricing model that an assets expected return is determined by its equilibrium risk to. Green the editor and to the referee for valuable expositional advice.
We derive a macroeconomic asset pricing model in which the key factor is the opportunity cost of money. Roll and ross 1994 explain this phenomenon happen because of a choice a wrong index. The first goal of this paper is to provide a systematic investigation of how the stochastic volatility of the market is priced in the cross. Hence, stocks with different sensitivities to innovations in aggregate volatility should have different expected returns. The resulting set of zeroinvestment cps, which go long a portfolio of high characteristic rms and short a portfolio of low characteristic rms, then serve as a model for returns in. Predictability and the cross section of expected returns in models with longrun risks. Deep learning, stock returns, cross section, forecasting, neural networks, industrial application. Our goal is to provide guidance as to the appropriate significance level using a multiple testing framework.
We predict that booktomarket strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings. Organization capital and the crosssection of expected returns. The crosssection of expected stock returns 429 also possible, however, that beme just captures the unraveling regression toward the mean of irrational market whims about the prospects of firms. The crosssection of volatility and expected returns. The remarkable multidimensionality in the crosssection of.
Market frictions, price delay, and the crosssection of expected returns abstract we parsimoniously characterize the severity of market frictions a. I am grateful to christopher malloy and andrew jackson for thoughtful comments and suggestions. Risk, uncertainty, and expected returns journal of. The remarkable multidimensionality in the cross section of expected u.
Thus, they conclude that beta is neither a single relevant risk measure nor a subset of. Given that so many papers have attempted to explain the same cross section of expected returns, statistical inference should not be based on a single test perspective. However, since that time, hundreds of papers have tried to explain the cross section of expected returns. Outofsample forecasts from fm regressions provide a simple, yet surprisingly effective, way to form a composite trading strategy going long high expected return stocks. Hundreds of papers and factors attempt to explain the crosssection of expected returns. Media coverage and the crosssection of stock returns. Pdf the crosssection of volatility and expected returns. The resulting set of zeroinvestment cps, which go long a portfolio of high characteristic rms and short a portfolio of low characteristic rms, then serve as a model for returns.
Eisfeldt and dimitris papanikolaou abstract organization capital is a production factor that is embodied in the rms key talent and has an e ciency that is rm speci c. Funding liquidity and the cross section of stock returns adrian and etula, 2010 and intermediary leverage and the crosssection of expected returns muir, 2010. What is cross section in cross section of stock return. Section of expected stock returns wiley online library. Two easily measured variables, size me and booktomarket equity. Market frictions, price delay, and the crosssection of. Size and booktomarket factors in earnings and returns. In particular, many authors attempt to explain the cross section of stock returns by using. We extend and enrich the finding of a recent paper by bali, cakici, and whitelaw. The cross section of expected stock returns 3 available at the time i. Common risk factors in the returns on stocks and bonds.
Forecast dispersion and the crosssection of expected returns. So intuitively, if you study the cross section of stock returns, you want to answer the question why stock a earns higherlower returns than stock b. Cross section of expected returns and extreme returns. Duarte and jones 2007 use deltahedged options to study properties of individual stock volatility risk. Low r square in the cross section of expected returns. Among them are levy 1978, merton 1987, and malkiel and xu 2002. They show that there exist some indices that make true betas not to have any relationship zero correlation with true expected returns.
G12 abstract motivated by existing evidence of a preference among investors for assets with lotterylike payoffs. We want to determine if the volatility of the market is a priced risk factor and estimate the price of aggregate volatility risk. Underdiversified investors demand a return compensation for bearing idiosyncratic risk. Given this extensive data mining, it does not make any economic or statistical sense to use the usual significance criteria for a newly discovered factor, e. Crosssection of expected returns and extreme returns. Consumption risk and the cross section of expected returns. Interest rate risk and the cross section of stock returns. A new factor model consisting of the market factor, an investment factor, and a return onequity factor is a good start to understanding the crosssection of expected stock returns. Information quality and the crosssection of expected returns. Banking, finance and accounting business liquidity finance portfolio management methods ratio analysis time series analysis timeseries analysis. But a recent paper by ang, hodrick, xing, and zhang 2006, ahxz hereafter finds that, in the cross section of.
Retained earningstomarket predicts the cross section of average returns in u. But the true cross sectional expected return beta relation is exact when the index is efficient, so no variable other than beta can explain any part of the true cross section of expected returns. Second, the ratio of booktomarket equity and size are found to be the most significant variables that can account for the crosssection of expected stock returns. Cash holdings, risk, and expected returns dino palazzo. This sentiment is reflected in the paper at hand the cross section of expected stock returns by jonathon lewellen. Ep is likely to be higher prices are lower relative to earnings for stocks with higher risks and expected returns, whatever the unnamed sources of risk. From these regressions we take the 36 month postranking. Risk, uncertainty, and expected returns volume 51 issue 3 turan g. Deep learning for forecasting stock returns in the cross. Cross section of volatility and expected returns 261 of assets that may have different exposures to aggregate volatility and hence different average returns.
There are several advantages of using a cross section of returns on stocks, rather than a cross section of options on the market, to estimate the price of risk of aggregate volatility. Because of infrequent trading, time series of housing returns are not available at the property level. Hundreds of papers and hundreds of factors attempt to explain the crosssection of expected returns. The conditional beta and the crosssection of expected returns. What are the key factors explaining cross sectional variation in expected returns. Ball, ray and gerakos, joseph and linnainmaa, juhani t. However, since that time, hundreds of papers have tried to explain the cross.
1434 444 411 583 35 261 956 423 1009 22 479 359 1116 1048 1456 413 1382 1001 1458 749 332 1379 1205 312 1129 339 780 981 543 363 321 617 1089 515 294 1289 1111 953 663 1054