Intertemporal Risk and the Cross Section of Expected Stock Returns

Abstract

Existing portfolio-level evidence about the Intertemporal Capital Asset Pricing Model (ICAPM) of Merton (1973) and Campbell (1996) is mixed. To avoid problems associated with the use of portfolios to test asset-pricing models, I develop a new firm-level approach to test the ICAPM while overcoming potential econometric issues with using individual stocks. The ICAPM performs quite well, explaining a substantial portion of the variation in average returns left unexplained by the CAPM. Moreover, investors accept lower returns on assets that hedge against adverse shifts in the investment opportunity set, consistent with equilibrium ICAPM predictions. I also investigate the conjecture that the SMB and HML factors of the Fama-French (1993) model proxy for intertemporal risk. The empirical evidence suggests the Fama-French model is not an ICAPM model.