Over the years, many asset pricing studies have employed the sample cross-sectional regression (CSR) R² as a measure of model performance. We derive the asymptotic distribution of this statistic and ...develop associated model comparison tests, taking into account the impact of model misspecification on the variability of the CSR estimates. We encounter several examples of large R² differences that are not statistically significant. A version of the intertemporal capital asset pricing model (CAPM) exhibits the best overall performance, followed by the Fama-French three-factor model. Interestingly, the performance of prominent consumption CAPMs is sensitive to variations in experimental design.
Asset pricing with liquidity risk Acharya, Viral V.; Pedersen, Lasse Heje
Journal of financial economics,
08/2005, Volume:
77, Issue:
2
Journal Article
Peer reviewed
Open access
This paper solves explicitly a simple equilibrium model with liquidity risk. In our liquidity-adjusted capital asset pricing model, a security's required return depends on its expected liquidity as ...well as on the covariances of its own return and liquidity with the market return and liquidity. In addition, a persistent negative shock to a security's liquidity results in low contemporaneous returns and high predicted future returns. The model provides a unified framework for understanding the various channels through which liquidity risk may affect asset prices. Our empirical results shed light on the total and relative economic significance of these channels and provide evidence of flight to liquidity.
Value and Momentum Everywhere ASNESS, CLIFFORD S.; MOSKOWITZ, TOBIAS J.; PEDERSEN, LASSE HEJE
The Journal of finance (New York),
June 2013, Volume:
68, Issue:
3
Journal Article
Peer reviewed
Open access
We find consistent value and momentum return premia across eight diverse markets and asset classes, and a strong common factor structure among their returns. Value and momentum returns correlate more ...strongly across asset classes than passive exposures to the asset classes, but value and momentum are negatively correlated with each other, both within and across asset classes. Our results indicate the presence of common global risks that we characterize with a three-factor model. Global funding liquidity risk is a partial source of these patterns, which are identifiable only when examining value and momentum jointly across markets. Our findings present a challenge to existing behavioral, institutional, and rational asset pricing theories that largely focus on U.S. equities.
Salience and Asset Prices Bordalo, Pedro; Gennaioli, Nicola; Shleifer, Andrei
The American economic review,
05/2013, Volume:
103, Issue:
3
Journal Article
Peer reviewed
Open access
We present a simple model of asset pricing in which payoff salience drives investors' demand for risky assets. The key implication is that extreme payoffs receive disproportionate weight in the ...market valuation of assets. The model accounts for several puzzles in finance in an intuitive way, including preference for assets with a chance of very high payoffs, an aggregate equity premium, and countercyclical variation in stock market returns. PUBLICATION ABSTRACT
The capital asset pricing model (CAPM) of William Sharpe (1964) and John Lintner (1965) marks the birth of asset pricing theory (resulting in a Nobel Prize for Sharpe in 1990). Before their ...breakthrough, there were no asset pricing models built from first principles about the nature of tastes and investment opportunities and with clear testable predictions about risk and return. Four decades later, the CAPM is still widely used in applications, such as estimating the cost of equity capital for firms and evaluating the performance of managed portfolios. And it is the centerpiece, indeed often the only asset pricing model taught in MBA level investment courses.
The attraction of the CAPM is its powerfully simple logic and intuitively pleasing predictions about how to measure risk and about the relation between expected return and risk. Unfortunately, perhaps because of its simplicity, the empirical record of the model is poor - poor enough to invalidate the way it is used in applications. The model's empirical problems may reflect true failings. (It is, after all, just a model.) But they may also be due to shortcomings of the empirical tests, most notably, poor proxies for the market portfolio of invested wealth, which plays a central role in the model's predictions. We argue, however, that if the market proxy problem invalidates tests of the model, it also invalidates most applications, which typically borrow the market proxies used in empirical tests. For perspective on the CAPM's predictions about risk and expected return, we begin with a brief summary of its logic. We then review the history of empirical work on the model and what it says about shortcomings of the CAPM that pose challenges to be explained by more complicated models.
Survey evidence suggests that many investors form beliefs about future stock market returns by extrapolating past returns. Such beliefs are hard to reconcile with existing models of the aggregate ...stock market. We study a consumption-based asset pricing model in which some investors form beliefs about future price changes in the stock market by extrapolating past price changes, while other investors hold fully rational beliefs. We find that the model captures many features of actual prices and returns; importantly, however, it is also consistent with the survey evidence on investor expectations.
The downside risk capital asset pricing model (DR-CAPM) can price the cross section of currency returns. The market-beta differential between high and low interest rate currencies is higher ...conditional on bad market returns, when the market price of risk is also high, than it is conditional on good market returns. Correctly accounting for this variation is crucial for the empirical performance of the model. The DR-CAPM can jointly rationalize the cross section of equity, equity index options, commodity, sovereign bond and currency returns, thus offering a unified risk view of these asset classes. In contrast, popular models that have been developed for a specific asset class fail to jointly price other asset classes.
Asset pricing: A tale of night and day Hendershott, Terrence; Livdan, Dmitry; Rösch, Dominik
Journal of financial economics,
12/2020, Volume:
138, Issue:
3
Journal Article
Peer reviewed
The capital asset pricing model (CAPM) performs poorly overall, as market risk (beta) is weakly related to 24-h returns. This is because stock prices behave very differently with respect to their ...sensitivity to beta when markets are open for trading versus when they are closed. Stock returns are positively related to beta overnight, whereas returns are negatively related to beta during the trading day. These day-night relations hold for beta-sorted portfolios and individual stocks in the US and internationally as well as for industry and book-to-market portfolios and cash flow and discount rate beta-sorted portfolios. In addition to the change in slope of returns with respect to beta, the implied risk-free rate differs significantly between night and day. Consistent with this, returns on US Treasury futures differ significantly between night and day.
Between 1934 and 1974, the Federal Reserve changed the initial margin requirement for the U.S. stock market 22 times. I use this variation to show that investors' leverage constraints affect the ...pricing of risk. Consistent with earlier theoretical predictions, I find that tighter leverage constraints result in a flatter relation between betas and expected returns. My results provide strong empirical support for the idea that the constraints investors face may help explain the empirical failure of the capital asset pricing model.
Ownership competence Foss, Nicolai J.; Klein, Peter G.; Lien, Lasse B. ...
Strategic management journal,
February 2021, Volume:
42, Issue:
2
Journal Article
Peer reviewed
Open access
Research Summary
Ownership is fundamental to firm strategy, organization, and governance. Standard ownership concepts—mainly derived from agency and incomplete contracting theories—focus on its ...incentive effects. However, these concepts and theories neglect ownership's role as an instrument to match judgment about resource use and governance with the firm's evolving environment under uncertainty. We develop the concept of ownership competence—the skill with which ownership is used as an instrument to create value—and decompose it into matching competence (what to own), governance competence (how to own), and timing competence (when to own). We describe how property rights of use, appropriation, and transfer relate to the three ownership competences and show how our theory offers a fresh perspective into the role of ownership for value generation.
Managerial Summary
Business owners own with different levels of competence, and differences in ownership competence matter for value creation. We argue that ownership competence consists of competence about what to own (matching competence), competence about how to own (governance competence), and competence about when to own (timing competence). We clarify the role played by each of the three competences for value creation. We also show how the importance of ownership competence for value creation alters depending on ownership concentration, life cycle effects, uncertainty of the environment, and the efficiency of resource markets. With our paper, we prepare the ground for a fuller understanding of the strategic role of owners for value creation.
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