Showing papers on "Capital asset pricing model published in 2012"

Digesting Anomalies: An Investment Approach

Abstract: Motivated from investment-based asset pricing, we propose a new factor model that consists of the market factor, a size factor, an investment factor, and a return-on-equity factor The new model [i] outperforms the Carhart (1997) four-factor model in pricing portfolios formed on earnings surprise, idiosyncratic volatility, financial distress, equity issues, as well as on investment and return-on-equity; [ii] performs similarly as the Carhart model in pricing portfolios on momentum as well as on size and book-to-market; but [iii] underperforms in pricing the total accrual deciles Our model's performance, combined with its clear economic intuition, suggests that it can serve as a new workhorse model for academic research and investment management practice

Intermediary Asset Pricing

Abstract: We model the dynamics of risk premia during crises in asset markets where the marginal investor is a financial intermediary. Intermediaries face an equity capital constraint. Risk premia rise when the constraint binds, reflecting the capital scarcity. The calibrated model matches the nonlinearity of risk premia during crises, and the speed of reversion in risk premia from a crisis back to pre-crisis levels. We evaluate the effect of three government policies: reducing intermediaries borrowing costs, injecting equity capital, and purchasing distressed assets. Injecting equity capital is particularly effective because it alleviates the equity capital constraint that drives the model's crisis.

An Empirical Evaluation of the Long-Run Risks Model for Asset Prices

Abstract: We provide an empirical evaluation of the Long-Run Risks (LRR) model, and highlight important differences in the asset pricing implications of the LRR model relative to the habit model. We feature three key results: (i) consistent with the LRR model there is considerable evidence in the data for time-varying expected consumption growth and consumption volatility, (ii) the LRR model matches the key asset markets data features, (iii) in the data and in the LRR model accordingly, lagged consumption growth does not predict the future price-dividend ratio, while in the habit-model it counterfactually predicts the future price-dividend with an R 2 of over 40%. Overall, we find considerable

Information Asymmetry, Information Precision, and the Cost of Capital

Abstract: The consequences of information differences across investors in capital markets are still much debated. This paper examines the relation between information differences across investors and the cost of capital. Our analysis makes three salient points. First, in models of perfect competition, information differences across investors affect a firm’s cost of capital through investors’ average information precision, and not information asymmetry per se. Second, the average information precision effect is unlikely to diversify away when there exist many firms whose cash flows covary. Finally, in models of imperfect competition information asymmetry affects the willingness to supply liquidity; this, in turn, affects a firm’s cost of capital. Thus, the precision of the information and information asymmetry have separate and distinct effects on the cost of capital. Failure to distinguish between them jeopardizes our understanding of the link between information and the cost of capital.

On the timing and pricing of dividends

Abstract: A central question in economics is how to discount future cash flows to obtain today's value of an asset. For instance, total wealth is the price of a claim to all future consumption (Lucas 1978). Similarly, the value of the aggregate stock market equals the sum of discounted future dividend payments (Gordon 1962). The major ity of the equity market literature has focused on the dynamics of the value of the aggregate stock market. However, in addition to studying the value of the sum of discounted dividends, exploring the properties of the individual terms in the sum, also called dividend strips, provides us with a lot of information about the way stock prices are formed. Analogous to zero-coupon bonds, which contain information about discount rates at different horizons for fixed income securities, having infor mation on dividend strips informs us about discount rates of risky cash flows at dif ferent horizons. Studying dividend strips can therefore improve our understanding of investors' risk preferences and the endowment or technology process in macro finance models. This paper is the first to empirically measure the prices of dividend strips to study the term structure of the equity premium. Our approach requires only no-arbitrage relations and does not rely on a specific model. We shed new light on the composition of the equity risk premium. The equity premium puzzle, identified by Mehra and Prescott (1985), Hansen and Singleton (1982), and Hansen and Singleton (1983), states that, for plausible values of the risk aversion coefficient, the difference in the expected rate of return on the stock market and the riskless rate of interest is too large, given the observed small variance in the growth rate in per capita consumption. When decomposing the index into dividend strips, a natural question that arises is whether dividends at different horizons contrib ute equally to the equity risk premium or whether either short- or long-term dividends contribute proportionally more than the other. We find that short-term dividends have

Testing Asymmetric-Information Asset Pricing Models

Abstract: We provide evidence for the importance of information asymmetry in asset pricing by using three natural experiments. Consistent with rational expectations models with multiple assets and multiple signals, we find that prices and uninformed demand fall as asymmetry increases. These falls are larger when more investors are uninformed, turnover is larger and more variable, payoffs are more uncertain, and the lost signal is more precise. Prices fall partly because expected returns become more sensitive to liquidity risk. Our results confirm that information asymmetry is priced and imply that a primary channel that links asymmetry to prices is liquidity. (JEL G12, G14, G17, G24) Theoretical asset pricing models routinely assume that investors have heterogeneous information. The goal of this article is to establish the empirical relevance of this assumption for equilibrium asset prices and investor demands. To do so, we exploit a novel identification strategy that allows us to infer changes in the distribution of information among investors and hence to quantify the effect of information asymmetry on prices and demands. Our results suggest that information asymmetry has a substantial effect on prices and demands and affects assets through a liquidity channel. Asymmetric-information asset pricing models typically rely on a noisy rational expectations equilibrium (REE) in which prices, due to randomness in the risky asset’s supply, only partially reveal the better-informed investors’ information. Random supply might reflect the presence of “noise traders” whose demands are independent of information. Prominent examples of such models include Grossman and Stiglitz (1980), Hellwig (1980), Admati (1985), Wang (1993), and Easley and O’Hara (2004).

Does Systemic Risk in the Financial Sector Predict Future Economic Downturns

Abstract: We derive a measure of aggregate systemic risk, designated CATFIN, that complements bank-specific systemic risk measures by forecasting macroeconomic downturns six months into the future using out-of-sample tests conducted with US, European and Asian bank data. Consistent with bank "specialness," the CATFIN of both large and small banks forecasts macroeconomic declines, whereas a similarly defined measure for both nonfinancial firms and simulated "fake banks" has no marginal predictive ability. High levels of systemic risk in the banking sector impact the macroeconomy through aggregate lending activity. A conditional asset pricing model shows that CATFIN is priced for financial and non-financial firms.

Leverage Aversion and Risk Parity

Abstract: The authors show that leverage aversion changes the predictions of modern portfolio theory: Safer assets must offer higher risk-adjusted returns than riskier assets. Consuming the high risk-adjusted returns of safer assets requires leverage, creating an opportunity for investors with the ability to apply leverage. Risk parity portfolios exploit this opportunity by equalizing the risk allocation across asset classes, thus overweighting safer assets relative to their weight in the market portfolio.

Ambiguity, Learning, and Asset Returns ⁄

Abstract: We develop a consumption-based asset-pricing model in which the representative agent is ambiguous about the hidden state in consumption growth. He learns about the hidden state under ambiguity by observing past consumption data. His preferences are represented by the smooth ambiguity model axiomatized by Klibanofi et al. (2005, 2006). Unlike the standard Bayesian theory, this utility model implies that the posterior of the hidden state and the conditional distribution of the consumption process given a state cannot be reduced to a predictive distribution. By calibrating the ambiguity aversion parameter, the subjective discount factor, and the risk aversion parameter (with the latter two values between zero and one), our model can match the flrst moments of the equity premium and riskfree rate found in the data. In addition, our model can generate a variety of dynamic asset pricing phenomena, including the procyclical variation of price-dividend ratios, the countercyclical variation of equity premia and equity volatility, and the mean reversion and long horizon predictability of excess returns.

Market Expectations in the Cross Section of Present Values

Abstract: Returns and cash flow growth for the aggregate U.S. stock market are highly and robustly predictable. Using a single factor extracted from the cross section of book- to-market ratios, we find an out-of-sample return forecasting R-squared as high as 13% at the annual frequency (0.9% monthly). We document similar out-of-sample predictability for returns on value, size, momentum and industry-sorted portfolios. We present a model linking aggregate market expectations to disaggregated valuation ratios in a dynamic latent factor system. We find that spreads in growth and value portfolios’ exposures to economic shocks are key to identifying predictability and are consistent with duration-based theories of the value premium. Our findings suggest that discount rates are far less persistent, and their shocks far more volatile, than implied by leading asset pricing models.

Trading Costs of Asset Pricing Anomalies

Abstract: Using nearly a trillion dollars of live trading data from a large institutional money manager across 19 developed equity markets over the period 1998 to 2011, we measure the real-world transactions costs and price impact function facing an arbitrageur and apply them to size, value, momentum, and shortterm reversal strategies. We find that actual trading costs are less than a tenth as large as, and therefore the potential scale of these strategies is more than an order of magnitude larger than, previous studies suggest. Furthermore, strategies designed to reduce transactions costs can increase net returns and capacity substantially, without incurring significant style drift. Results vary across styles, with value and momentum being more scalable than size, and short-term reversals being the most constrained by trading costs. We conclude that the main anomalies to standard asset pricing models are robust, implementable, and sizeable.

Does Systemic Risk in the Financial Sector Predict Future Economic Downturns

Abstract: We derive a measure of aggregate systemic risk, designated CATFIN, that complements bank-specific systemic risk measures by forecasting macroeconomic downturns six months into the future using out-of-sample tests conducted with U.S., European, and Asian bank data. Consistent with bank "specialness," the CATFIN of both large and small banks forecasts macroeconomic declines, whereas a similarly defined measure for both nonfinancial firms and simulated "fake banks" has no marginal predictive ability. High levels of systemic risk in the banking sector impact the macroeconomy through aggregate lending activity. A conditional asset pricing model shows that CATFIN is priced for financial and nonfinancial firms. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Low Risk Stocks Outperform within All Observable Markets of the World

Abstract: This article provides global evidence supporting the Low Volatility Anomaly: that low risk stocks consistently provide higher returns than high risk stocks. This study covers 33 different markets during the time period from 1990-2011. (Two previous studies by Haugen & Heins (1972) and Haugen & Baker (1991) show the same negative payoff to risk in time periods 1926-1970 and 1970-1990.) The procedure for our study is intentionally simple, transparent and easily replicable. Our samples include non-survivors. We look at an international universe of stocks beginning with the first month of 1990 until December 2011; we compute the volatility of total return for each company in each country over the previous 24 months. Stocks in each country are ranked by volatility and formed into deciles. In the total universe and in each individual country low risk stocks outperform, the relationship with respect to Sharpe ratios is even more impressive. We believe this anomaly is caused primarily by agency issues, namely the compensation structures and internal stock selection processes at asset management firms which lead institutional investors on average to hold more volatile stocks. The article also addresses the implications for how corporate finance managers make capital investment decision in light of this evidence. The evidence presented here dethrones both CAPM and the Efficient Market Hypothesis.

Bond Liquidity Premia

Abstract: Recent asset pricing models of limits to arbitrage emphasize the role of funding conditions faced by financial intermediaries. In the US, the repo market is the key funding market. Then, the premium of on-the-run U.S. Treasury bonds should share a common component with risk premia in other markets.

Ambiguous Volatility and Asset Pricing in Continuous Time

Abstract: This paper formulates a model of utility for a continuous time frame-work that captures the decision-maker’s concern with ambiguity about both volatility and drift. Corresponding extensions of some basic results in asset pricing theory are presented. First, we derive arbitrage-free pricing rules based on hedging arguments. Ambiguous volatility implies market incompleteness that rules out perfect hedging. Consequently, hedging arguments determine prices only up to intervals. However, sharper predictions can be obtained by assuming preference maximization and equilibrium. Thus we apply the model of utility to a representative agent endowment economy to study equilibrium asset returns. A version of the C-CAPM is derived and the effects of ambiguous volatility are described.

The Accrual Anomaly: Risk or Mispricing?

Abstract: We document considerable return comovement associated with accruals after controlling for other common factors. An accrual-based factor-mimicking portfolio has a Sharpe ratio of 0.16, higher than that of the market factor or the SMB and HML factors of Fama and French. According to rational frictionless asset pricing models, the ability of accruals to predict returns should come from the loadings on this accrual factor-mimicking portfolio. However, our tests indicate that it is the accrual characteristic rather than the accrual factor loading that predicts returns. These findings suggest that investors misvalue the accrual characteristic and cast doubt on the rational risk explanation. This paper was accepted by Brad Barber, Teck Ho, and Terrance Odean, special issue editors.

Digesting Anomalies: An Investment Approach

Abstract: Motivated from investment-based asset pricing, we propose a new factor model that consists of the market factor, a size factor, an investment factor, and a return-on-equity factor. The new model [i] outperforms the Carhart (1997) four-factor model in pricing portfolios formed on earnings surprise, idiosyncratic volatility, financial distress, equity issues, as well as on investment and return-on-equity; [ii] performs similarly as the Carhart model in pricing portfolios on momentum as well as on size and book-to-market; but [iii] underperforms in pricing the total accrual deciles. Our model’s performance, combined with its clear economic intuition, suggests that it can serve as a new workhorse model for academic research and investment management practice.

Empirical cross-sectional asset pricing: a survey

Abstract: I review the state of empirical asset pricing devoted to understanding cross-sectional differences in average rates of return. Both methodologies and empirical evidence are surveyed. Tremendous progress has been made in understanding return patterns. At the same time, there is a need to synthesize the huge amount of collected evidence.

Fiscal Policies and Asset Prices

Abstract: The surge in public debt triggered by the financial crisis has raised uncertainty about future tax pressure and economic activity. We examine the asset pricing effects of fiscal policies in a production-based general equilibrium model in which taxation affects corporate decisions by: (1) distorting profits and investment; (2) reducing the cost of debt through a tax shield; and (3) depressing productivity growth. In settings with recursive preferences, these three tax-based channels generate sizable risk premia, making tax uncertainty a first-order concern. We document further that corporate tax smoothing can substantially alter the effects of public expenditure shocks.

Composition Of Time-Consistent Dynamic Monetary Risk Measures In Discrete Time

Abstract: In discrete time, every time-consistent dynamic monetary risk measure can be written as a composition of one-step risk measures. We exploit this structure to give new dual representation results for time-consistent convex monetary risk measures in terms of one-step penalty functions. We first study risk measures for random variables modelling financial positions at a fixed future time. Then we consider the more general case of risk measures that depend on stochastic processes describing the evolution of financial positions or cumulated cash flows. In both cases the new representations allow for a simple composition of one-step risk measures in the dual. We discuss several explicit examples and provide connections to the recently introduced class of dynamic variational preferences.

The Inventory Growth Spread

Abstract: Previous studies show that firms with low inventory growth outperform firms with high inventory growth in the cross-section of publicly traded firms. In addition, inventory investment is volatile and procyclical, and inventory-to-sales is persistent and countercyclical. We embed an inventory holding motive into the investment-based asset pricing framework by modeling inventory as a factor of production with convex and nonconvex adjustment costs. The augmented model simultaneously matches the large inventory growth spread in the data, as well as the time-series properties of the firm level capital investment, inventory investment, and inventory-to-sales. Our conditional single-factor model also implies that traditional unconditional factor models such as the CAPM should fail to explain the inventory growth spread, although not with the same large pricing errors observed in the data.