Cross-section Of Excess Returns Research Articles

Consumption Risk, Stock Returns, and Economic Cycles

We decompose the standard consumption beta into two components that measure consumption risk in high and low economic activity states. Recessionary consumption risk commands a positive and statistically significant compensation, while the market price of expansionary consumption risk is not robust. The two-beta model explains well the cross-section of excess returns on book-to-market-, size-, and momentum-sorted portfolios, and substantially outperforms the traditional one-beta model. The results hold through for various business cycle classifications and alternative consumption measures.

Asset Pricing with Countercyclical Household Consumption Risk

ABSTRACTWe show that shocks to household consumption growth are negatively skewed, persistent, countercyclical, and drive asset prices. We construct a parsimonious model where heterogeneous households have recursive preferences. A single state variable drives the conditional cross‐sectional moments of household consumption growth. The estimated model fits well the unconditional cross‐sectional moments of household consumption growth and the moments of the risk‐free rate, equity premium, price‐dividend ratio, and aggregate dividend and consumption growth. The model‐implied risk‐free rate and price‐dividend ratio are procyclical, while the market return has countercyclical mean and variance. Finally, household consumption risk explains the cross section of excess returns.

MBS Liquidity: Drivers and Risk Premiums

This paper shows that funding liquidity risk is priced in the cross-section of excess returns on agency mortgage-backed securities (MBS). We derive a measure of funding liquidity risk from dollar-roll implied financing rates (IFRs), which reflect security-level costs of financing positions in the MBS market. We show that factors representing higher net MBS supply are generally associated with higher IFRs, or higher funding costs. In addition, we find that exposure to systematic funding liquidity shocks embedded in the IFRs is compensated in the cross-section of expected excess returns| agency MBS that are better hedges to funding liquidity shocks on average deliver lower excess returns-and that these premiums are separate from the premiums associated with prepayment risks.

Funding Liquidity Risk and the Cross-section of MBS Returns

This paper shows that funding liquidity risk is priced in the cross-section of excess returns on agency mortgage-backed securities (MBS). We derive a measure of funding liquidity risk from dollar-roll implied financing rates (IFRs), which reflect security-level costs of financing positions in the MBS market. We show that factors representing higher net MBS supply are generally associated with higher IFRs, or higher funding costs. In addition, we find that exposure to systematic funding liquidity shocks embedded in the IFRs is compensated in the cross-section of expected excess returns| agency MBS that are better hedges to funding liquidity shocks on average deliver lower excess returns-and that these premiums are separate from the premiums associated with prepayment risks.

The Crash Risk Premia of Efficient Carry Trades

Carry trade strategies in which investors sell forward currencies that are at a forward premium and buy forward currencies that are at a forward discount are, on average, profitable. According to the uncovered interest rate parity they should not. A risk premia story might justify the high returns to the carry trades. In this paper we study the relationship between the cross section of excess returns of portfolios invested in carry trade positions and a renewed set of candidate risk factors. Asset pricing theory applies to the currency market: those currencies that have larger loading on risk, especially crash risk, offer a larger mean return in compensation. Especially, we show that crash risk as measured by quantile based statistics such as VaR or CVaR prices better the return to the carry trades than moments based factors such as standard deviation or skewness. This result holds at the portfolio level and at the single currency level. As a result, we show that carry trade strategies that take account of the dispersion of interest rates dominate strategies in which bets are normalized.

Carry Trades and Global Foreign Exchange Volatility

ABSTRACTWe investigate the relation between global foreign exchange (FX) volatility risk and the cross section of excess returns arising from popular strategies that borrow in low interest rate currencies and invest in high interest rate currencies, so‐called “carry trades.” We find that high interest rate currencies are negatively related to innovations in global FX volatility, and thus deliver low returns in times of unexpected high volatility, when low interest rate currencies provide a hedge by yielding positive returns. Furthermore, we show that volatility risk dominates liquidity risk and our volatility risk proxy also performs well for pricing returns of other portfolios.

Production-Based Asset Pricing in a Monetary Economy: Theory and Evidence

This paper considers capital asset pricing based on the production side of a monetary economy. Relying on a general version of the traditional Real Business Cycle model with cash and credit goods, we find that the variables determining the mean excess returns of all financial assets are i) capital growth, ii) the nominal rate and iii) the capital to wealth. Ratio. Our model is parsimonious in that the results do not lean on any particular specification of the production function nor capital adjustment costs. Empirical evidence gives strong support to the presence of the elicited factors in the cross section of excess returns on portfolios sorted i) by firm characteristics or ii) by industry. Both unconditional and conditional versions of the model are shown to perform as well as the Fama-French (1993) three-factor model when the universe of 25 portfolios sorted by size and book to market ratio is considered. On an extended portfolio universe, our model is shown to perform slightly better than the Fama-French model. We also show that our macro-related risk variables have some predicting power for the aggregate dividend yield and equity market premium

Estimating the cost of capital of the UK's newly privatized utilities

In this paper the cost of capital of the UK's newly privatized utilities is estimated using both the CAPM and the APT. It is found that the APT provides a better description of excess security returns than the CAPM. However, neither model can explain the crosssection of excess returns on the sample of UK utilities. The failure of the factor models is traced to the existence of considerable idiosyncratic risk inherent in the utility stocks.