Ambiguity in asset pricing and portfolio choice: a review of the literature
A growing body of empirical evidence suggests that investors? behavior is not well described by the traditional paradigm of (subjective) expected utility maximization under rational expectations. A literature has arisen that models agents whose choices are consistent with models that are less restrictive than the standard subjective expected utility framework. In this paper we conduct a survey of the existing literature that has explored the implications of decision-making under ambiguity for financial market outcomes, such as portfolio choice and equilibrium asset prices. We conclude that ...
Risk aversion vs. intertemporal substitution: identification failure in the intertemporal consumption CAPM
Is the risk aversion parameter in the simple intertemporal consumption CAPM ?small? as in Hansen and Singleton (1982,1983), or is it that its reciprocal, the intertemporal elasticity of substitution, is small, as in Hall (1988)? This paper attributes the disparate estimates of this fundamental parameter not only to failures of instrument admissibility as do Hall (1988) and Hansen-Singleton (1996), but rather to failures of instrument relevance. That is, the disparate estimates reflect near nonidentification due to the unpredictability of asset returns and consumption growth. One natural ...
Time-varying risk and international portfolio diversification with contagious bear markets
In this paper we estimate and test a conditional version of the international CAPM. By using a parsimonious parameterization recently proposed by Ding and Engle (1994), we allow risk premia, betas, and correlations to very through time and test the cross-section restrictions of the model using a relatively large number of assets. One advantage of our test is that it does not require the market weights to be observed in each period. In support of the international CAPM, we find that world-wide risk is priced whereas country-specific risk is not. Further, we find that the price of world risk is ...
Measuring the gains from international portfolio diversification
The conditional CAPM and the cross-section of expected returns
Most empirical studies of the static CAPM assume that betas remain constant over time and that the return on the value-weighted portfolio of all stocks is a proxy for the return on aggregate wealth. The general consensus is that the static CAPM is unable to explain satisfactorily the cross-section of average returns on stocks. We assume that the CAPM holds in a conditional sense, i.e., betas and the market risk premium vary over time. We include the return on human capital when measuring the return on aggregate wealth. Our specification performs well in explaining the cross-section of average ...
Asset returns and economic risk
The capital asset pricing model (CAPM), favored by financial researchers and practitioners fifteen years ago, holds that the extra return on a risky asset comes from bearing market risk only. But newer evidence supports the intertemporal CAPM (I-CAPM) theory (Merton 1973), which suggests that the premium on any risky asset is related not only to market risk but also to additional economic variables. ; This article reviews and interprets recent advances in the asset pricing literature. The study seeks to shed light on the sources of economic risk that investors should track and hedge against ...
Aggregate consumption-wealth ratio and the cross-section of stock returns: some international evidence
We find that the short-term deviations from long-run consumption-wealth relationship (cay) forecast stock market returns and serve as a conditioning variable in the capital asset pricing model (CAPM) for explaining the cross-section of stock returns for the United Kingdom and Japan. Our cross-sectional regressions using cay as a conditioning variable as opposed to using an alternative variable, tay, constructed using calendar time in place of consumption indicate that it is unlikely to be a spurious variable and provides useful information concerning the economic fundamentals. We show that ...
Information diffusion based explanations of asset pricing anomalies
In this paper we develop information based factors which outperform other popular factors used in the multifactor pricing literature such as the Fama and French size and book-to-market factors. The first factor is based on the age of an asset, measured by the number of months since the asset?s IPO, while the second factor is based on the percentage of trading days an asset does not trade in a given year. Both factors attempt to capture the quality and speed of information diffusion on the market. Our information factors perform particularly well on momentum portfolios, which, Hong et al ...
Market proxies, correlation, and relative mean-variance efficiency: still living with the roll critique
A pricing restriction is developed to test the validity of the CAPM conditional on a prior belief about the correlation between the true market return and the proxy return used in the test. Distinguishing this pricing restriction from competing tests also based upon the relative efficiency of the proxy return is a consideration for the proxy's mismeasurement of the market return. Failure to account for this mismeasurement biases tests of the CAPM towards rejection by overstating the inefficiency of the proxy. A time-varying version of this pricing restriction links mismeasurement of the ...