Crash sensitivity and the cross section of expected stock returns volume 53 issue 3 fousseni chabiyo, stefan ruenzi, florian weigert skip to main content accessibility help we use cookies to distinguish you from other users and to provide you with a better experience on our websites. Underdiversified investors demand a return compensation for bearing idiosyncratic risk. The crosssection of expected stock returns econpapers. This paper presents a new pattern in the cross section of expected stock returns. Gallen school of management, economics, law, social sciences and international a. Our goal is to provide guidance as to the appropriate significance level using a multiple testing framework. Crash sensitivity and the cross section of expected stock. January 15, 20 abstract aggregate stock market returns are naturally categorized as either small or large movements. Alternative profitability measures and cross section of. The conditional capm and the crosssection of expected returns 5 business cycle. Earnings, retained earnings, and booktomarket in the cross. Two easily measured variables, size and booktomarket equity, combine to capture the crosssectional variation in average stock returns associated with market b. This paper provides an extensive international analysis of the cross sectional return predictive power of a variety of firmlevel profitability measures, calculated from different combinations of three important measures of earnings gross profit, operating income, and ebit and four scaling variables enterprise value, book value of assets, market value of equity, and book value of. The book begins with thorough expositions of the most prevalent econometric techniques with indepth discussions of the implementation and interpretation of results illustrated through.
The cross section of expected stock returns by jonathan lewellen. We provide a systematic study of how stochastic volatility is priced in the cross section of expected stock returns. The crosssection of expected stock returns eugene f. Sellorder liquidity and the crosssection of expected.
The crosssection of expected stock returns critical finance. Price, cultural dimensions, and the cross section of expected stock returns ulrich j. These forecasts mimic how an investor could, in real time, combine many firm characteristics to get a composite estimate of a stocks expected return. October 2006 abstract this paper presents a new pattern in the crosssection of expected stock returns. Roberts june 2017 draft abstract using data spanning the 20th century, we show that the majority of accountingbased return anomalies, including investment and pro tability, are most likely an artifact of data snooping. Introduction there is a growing literature documenting a negative relationship between observed volatility and future stock returns. Crash sensitivity and the cross section of expected stock returns volume 53 issue 3 fousseni chabiyo, stefan ruenzi, florian weigert skip to main content accessibility help we use cookies to distinguish you from other users.
Calculating expected portfolio returns and portfolio variances. Aggregate jump and volatility risk in the crosssection of. The cross section 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. Crosssection of volatility and expected returns 261 of assets that may have different exposures to aggregate volatility and hence different average returns. Expected stock returns, predictability, outofsample. This sentiment is reflected in the paper at hand the crosssection of expected stock returns by jonathon lewellen. Empirically, the forecasts vary substantially across stocks and have strong predictive power for actual returns. Media coverage and the crosssection of stock returns. First, we cross sectionally estimate a price of risk for aggregate market volatility. This paper studies the crosssectional properties of return forecasts derived from famamacbeth regressions. A new factor model consisting of the market factor, an investment factor, and a returnonequity factor is a good start to understanding the cross section of expected stock returns.
Pdf the crosssection of expected stock returns semantic. Seasonality in the crosssection of stock returns steven l. Worldwide, stocks with strong crash sensitivity deliver average returns of more than. Jagannathan and runkle 1993, the question of how aggregate volatility affects the cross section of expected stock returns has received less attention. Book value of equity consists of two main components that we expect contain di er. Continuous beta, discontinuous beta, and the crosssection of. Price, cultural dimensions, and the crosssection of expected.
Crash aversion and the cross section of expected stock returns worldwide abstract this paper examines whether investors receive compensation for holding stocks with a strong sensitivity to extreme market downturns in a sample covering forty countries. Continuous beta, discontinuous beta, and the crosssection of expected stock returns sophia zhengzi liy job market paper this version. A professor in the department of finance at the college of business administration at the university of nebraskalincoln in lincoln ne 68588. The capital asset pricing model developed by sharpe 1964, lintner 1964 and black 1972 stipulate that the expected return on a stock is determined by the risk free interest rate and a risk premium. Pdf this paper explores the ability of the capital asset pricing model, as well as the firm specific factors, to explain the crosssectional. Firm characteristics such as size, booktomarket equity. We use the adaptive least absolute shrinkage and selection operator lasso to select. Crash sensitivity and the crosssection of expected stock returns. We want to determine if the volatility of the market is a priced risk factor and estimate the price of aggregate volatility risk.
These forecasts mimic how an investor could, in real time, combine many firm characteristics to obtain a composite estimate of a stockas expected return. 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. Given that so many papers have attempted to explain the same crosssection of expected returns, statistical inference should not be based on a single test perspective. Stocks with higher sensitivities to dispersion are found to offer lower returns. This study attempts to analyze and identify presence of herd behavior amongst investors, using daily returns of 387 stocks listed on pakistan stock. The efficiency of the market portfolio implies that a expected returns on securities are a positive linear function of their market. Financial economists have long been engrossed with explaining the cross section of stock returns. Also, to the extent that the business cycle is induced. Thus, we look for evidence on the pricing of the buy and sellorder illiquidity measures in the cross section of expected stock returns.
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. The crosssection of volatility and expected returns. The authors thank ariel zucker and daniel green for outstanding research assistance. This cited by count includes citations to the following articles in scholar. Thus, they conclude that beta is neither a single relevant risk measure nor a subset of variables in a multivariate specification to explain crosssectional stock returns variations of. We capture the crash sensitivity of stocks by their lower tail dependence ltd with the market based on copulas. Media coverage and the crosssection of stock returns 2025 and even firms public relation programs can affect firms cost of capital. Singapore management university institutional knowledge at. There are several empirical contradictions of the sharpelintnerblack slb model. Predicting stock returns using firm characteristics.
Graduate school of business, university of chicago, 1101 east 58th street, chicago, il 60637. Regarding the scaling measure, we find that irrespective of the choice of a profit measure, the crosssectional predictive relation of firm profitability and stock returns is more pronounced when profits are scaled by enterprise value or market value of equity. This paper studies the crosssectional properties of return forecasts derived from famamacbeth. Crosssectional analysis is a type of analysis that an investor, analyst or portfolio manager may conduct on a company in relation to that companys industry or. The history of the cross section of stock returns juhani t. Any rational asset pricing theory implies that expected stock returns admit a beta representation, where betas are computed with respect to a discount factor cochrane 2005. Crash sensitivity and the cross section of expected stock returns. They can be regarded as different ways of extracting information from stock prices about 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. Among them are levy 1978, merton 1987, and malkiel and xu 2002.
Stocks as lotteries and the crosssection of expected returns turan g. 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. The assetpricing literature finds significant crosssectional predictability in stock returns. The cross section of cashflow volatility and expected. Crash sensitivity and the cross section of expected stock returns abstract this paper examines whether investors receive compensation for holding crashsensitive stocks. Seasonality in the crosssection of expected stock returns. Earnings, retained earnings, and booktomarket in the cross section of expected returns abstract we delve into what causes the relation between booktomarket and the cross section of stock returns. If aggregate volatility is a risk factor that is orthogonal to existing risk factors, the sensitivity of stocks. What determines the cross section of expected stock returns. It is this unknown risk factor that we have in mind when we classify particular. This paper provides new evidence on the crosssectional properties of expected stock returns, focusing on two closely related questions that, to date, do not have clear answers in the literature. This question has been central to modern financial economics since the path breaking work of sharpe, lintner and mossin. The conditional capm and the cross section of expected returns 5 business cycle.
Cross section of expected stock returns in ise levent akdeniz asl. 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. Pdf the crosssection of expected stock returns jean. This paper studies the properties and predictive ability of return forecasts from famamacbeth crosssectional regressions.
But a recent paper by ang, hodrick, xing, and zhang 2006, ahxz hereafter finds that, in the crosssection of. The rational economic models in the mold of capm and apt have helped us understand the theoretical underpinnings of cross section of stock returns. Two easily measured variables, size me and booktomarket equity. The cross section of expected stock returns 5 the fm slopes. The authors examine the crosssection of expected stock returns between 1985 and 1994 and find a strong negative relationship between market value added per share mva and average returns. While market participants and company executives recognize that information dissemination plays a crucial role in determining the cost of capital, traditionally. P, leverage, and booktomarket equity in the cross section of average stock returns. Crosssection of expected returns and extreme returns. In the continuoustime model setup, we can formally identify these. Media coverage and the cross section 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. My results suggest that crosssectional regressions provide quite reliable estimates of expected returnsindeed, the estimates appear to be much more reliable than prior work has found for the implied cost of capital, though a direct.
Timevarying market volatility induces changes in the investment opportunity set by changing the expectation of future market returns, or by changing the riskreturn tradeoff. 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. Product market competition, gross profitability, and cross. Stocks tend to have relatively high or low returns every year in the same calendar month. Much of the predicted variation in expected returns is common to all three models, with pairwise correlations in their forecasts of 0. Whatever the underlying economic causes, our main result is straightfor ward. Regarding the scaling measure, we find that irrespective of the choice of a profit measure, the crosssectional predictive relation of firm profitability and stock returns is more pronounced when profits are scaled by.
Sellorder liquidity and the crosssection of expected stock. Mva and the crosssection of expected stock returns the. When we estimate the spanning tests post and pre1990, we find that retained earningstomarket subsumes the. To examine the impact of proximity of extreme stock returns to the end of daily the month and their subsequent reversal, we calculate dmax distance of max as the number of days between the day when the maximum daily return max is observed and. Funding liquidity and the cross section of stock returns adrian and etula, 2010 and intermediary leverage and the crosssection of expected returns muir, 2010. Many option studies have estimated a negative price of risk for market. Machine learning and the crosssection of expected stock returns dissertation university of st. The cross section of stock returns is a comprehensive overview of the most important findings of empirical asset pricing research. The ones marked may be different from the article in the profile.
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 sample covers stockreturns data over the period 19912016 from four regions in the world. Since all these variables are scaled versions of price, it is reasonable to expect that some of them are redundant for explaining average returns. Our focus is on uncovering contemporaneous effects because a contemporaneous relation between factor loadings and risk premiums is the foundation of a crosssectional risk return relation. The cross section of individual equity option returns abstract we examine a large set of potential determinants of expected option returns to identify the characteristics that can predict the expected returns of individual equity options. We find evidence of a significant negative premium for exposure to dispersion risk, where expected returns vary according to the stocks sensitivities to the aggregate dispersion factor. Ball 1978 argues that ep is a catchall proxy for unnamed factors in expected returns. It is this unknown risk factor that we have in mind when we classify. Financial intermediaries and the crosssection of asset returns.
Does systemic risk in the financial sector predict future economic downturns. April 2008 preliminary and incomplete abstract motivated by existing evidence of a preference among investors for assets with lotterylike payoffs and that. Machine learning and the crosssection of expected stock. Retained earnings comprise the accumulated total earnings the firm generated over its history less accumulated dividend distributions. First, we crosssectionally estimate a price of risk for aggregate market volatility. My paper also relates to fama and french 1997, simin 2008, and levi and welch 2014, who show that the capm and famafrench 1993 threefactor model do not provide reliable estimates of. First, when deflated by market values, earnings likely share common economic determinants with. Idiosyncratic risk and the crosssection of expected stock returns. The crosssection of individual equity option returns. Hundreds of papers and hundreds of factors attempt to explain the crosssection of expected returns.
We provide a systematic study of how stochastic volatility is priced in the crosssection of expected stock returns. How average returns change across different stock or portfolios. Stocks with relatively high low returns tend to have high low returns every year in the same calendar month. We find that sellorder illiquidity is priced more strongly in the crosssection of expected stock returns than is buyorder illiquidity.
We find that sellorder illiquidity is priced more strongly in the cross section of expected stock returns than is buyorder illiquidity. Aggregation of information about the cross section of. While market participants and company executives recognize that information dissemination plays a crucial role in. Common risk factors in the returns on stocks and bonds. Earnings, retained earnings, and booktomarket in the. The cross section of expected stock returns tuck school of business. Throughout the paper, our emphasis is on whether stocks expected returns are driven by their sensitivity to dispersion, after accounting for a large set of other systematic factors and stocks idiosyncratic characteristics. Crash sensitivity and the cross section of expected stock returns volume 53 issue 3 fousseni chabiyo, stefan ruenzi, florian weigert.
There is also evidence that investors have a preference for lotterylike assets, i. However, the nature of the discount factor remains elusive despite several decades of active academic research. We examine crosssectional anomalies in stock returns using handcollected accounting data extending back to the start of the 20th century. Forecasts based on longer histories of fm slopes work best and, statistically, are quite strongly related to subsequent annual returns. Crash aversion and the crosssection of expected stock. Size and booktomarket factors in earnings and returns. In addition, we investigate whether future jump and volatility risk. Pdf the crosssection of expected stock returns semantic scholar.
Expected stock returns idiosyncratic return volatility cross section 1. These forecasts mimic how an investor could, in real time, combine many firm characteristics to obtain a composite estimate of a stocks expected return. The conditional capm and the crosssection of expected. Abstract two easily measured variables, size and book. Thus, we look for evidence on the pricing of the buy and sellorder illiquidity measures in the crosssection of expected stock returns. May 12, 2019 abstract we document a nominal stock price effect that is like momentum associated with national. During a recession, for example, financial leverage of firms in relatively poor shape may increase sharply relative to other firms, causing their stock betas to rise.