Abstract
We derive a cross-sectional asset pricing measure from a noisy multi-asset rational expectations equilibrium model. The measure is based on the time-series covariance of an asset's returns and security prices. Empirically, stocks with a measure one standard deviation above and below the average have returns that di er by 0.36% the following month (4.44% per annum) which is statistically significant at the 1%-level. The findings are concentrated in the smallest three deciles of stocks using NYSE breakpoints. Results remain significant after including variables such as stock market capitalization, book-to-market ratio, and the probability of information-based trading. Our measure can be understood as a proxy for information risk and/or supply uncertainty. The two explanations cannot easily be disentangled.
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