Positive Risk Premium Research Articles

Aggregate volatility expectations and threshold CAPM

We propose a volatility-based capital asset pricing model (V-CAPM) in which asset betas change discretely with respect to changes in investors’ expectations regarding near-term aggregate volatility. Using a novel measure to proxy uncertainty about expected changes in aggregate volatility, i.e. monthly range of the VIX index (RVIX), we find that portfolio betas change significantly when uncertainty about aggregate volatility expectations is beyond a certain threshold level. Due to changes in their market betas, small and value stocks are perceived as riskier than their big and growth counterparts in bad times, when uncertainty about aggregate volatility expectations is high. The proposed model yields a positive and significant market risk premium during periods when investors do not expect significant uncertainty in near-term aggregate volatility. Our findings support a volatility-based time-varying risk explanation.

Crude Oil Prices, Risk Preferences, and Intertemporal Variation in Market Expected Returns: Empirical Evidence from the Nigerian Stock Exchange (NSE)

I find oil prices affect market or portfolio expected returns on the NSE only via changes induced in the risk preferences of the that has exposure to both stock market return volatility risk and oil price risk. This finding indicates oil prices do not affect portfolio returns on the NSE independent of their effects on the representative agent's risk preferences. In so far as the risk preference of the representative agent is concerned, empirical results characterize this agent as an hedging agent; that is, an agent who at the margin accepts negative risk premiums for market volatility risk. In empirical tests that substitute a portfolio subset of the NSE (the portfolio) whose pricing is shown to be characterized by risk aversion and skewness preference in Obrimah et al. (2015), the representative agent who holds the OAH portfolio and has exposure to oil price risk is a risk averse agent who at the margin demands positive risk premiums for market volatility risk. Combined, empirical findings imply the presence of multiple representative agents that have exposure to both stock market return volatility risk and oil price risk within the Nigerian Stock Exchange.

The Carbon Risk Factor (EMI - Efficient Minus Intensivee)

In the May’s Special Report 01: The Emerging Importance of Carbon Emission-Intensities and Scope 3 (Supply Chain) Emissions in Equity Returns ET Index Research demonstrated that a long carbon-efficient stocks short carbon-intensive stocks strategy generated statistically significant outperformance. In the following analysis ET Index Research investigates whether there is actually a systemic carbon risk factor now driving equity returns, in addition to the already known and accepted Market, Value, Size and Momentum factors. There is strong evidence for a carbon risk factor and it is labelled EMI (for ‘Efficient minus Intensive’). The EMI factor is found to attract a positive risk premium and to be uncorrelated with the other known risk factors.

THE ROLE OF THE DISCOUNT RATE IN EFFICIENCY MEASURING PROCESS OF FOOD INDUSTRY ENTERPRISES OVER THE ECONOMIC CRISIS IN POLAND

The work reads about the subject of the efficiency evaluation in the food industry enterprises over the economic crisis in Poland. The authors tried to prove the theorem that the applied assumption of using the constant discount rate in assessing enterprises efficiency is incorrect. In the first step, the definition of enterprises efficiency as well as the factors molding economic efficiency are shown. The measures of assessing enterprises efficiency are also shown. The fundamental part of the work is the empirical research, which proves the aim of the work. The content of the work consists of the research results related to ROE, own equity multiplier, risk premium, and weighted average cost of capital. The discount rate can be influenced by many factors e.g. Central Bank monetary policy, fiscal policy, capital structure, exchange rate, the value of gross domestic product. It is hard to expect that they will not change. To evaluate the real enterprise efficiency, its authentic measures should be assessed. If we assume that there is only positive risk premium and constant discount rate, the real efficiency level is counterfeited, especially during the periods of market crises. It is deceptive for investors and enterprise capital managers. The real assessment of efficiency measures is important because of the ambiguity of efficiency concept. In our case, it is simultaneously implied as effectiveness, economy, and proficiency. Considering the aim of the work, the measures of efficiency put to the research process were expressed by authoritative financial factors.

Downside risk analysis of returns on the Karachi Stock Exchange

Purpose – The purpose of this paper is to analyze the mean-variance capital asset pricing model (CAPM) and downside risk-based CAPM (DR-CAPM) developed by Bawa and Lindenberg (1977), Harlow and Rao (1989), and Estrada (2002) to assess which downside beta better explains expected stock returns. The paper also explores whether investors respond differently to stocks that co-vary with declining market than to those of co-vary with rising market. Design/methodology/approach – The paper uses monthly data of closing prices of stocks listed at the Karachi Stock Exchange (KSE). The data cover the period from January 2000 to December 2012. The standard, downside, and upside betas are estimated for different sub-periods,and then,their validity to quantify the risk premium is tested for subsequent sub-periods in a cross sectional regression framework. Though our empirical methodology is similar to that of Fama and MacBeth (1973) for testing the CAPM and the DR-CAPM, our approach to estimate the downside beta is different from earlier studies. In particular, we follow Estrada ' s (2002) suggestions and obtain the correct and unbiased estimation of the downside beta by running the time series regression through origin. The authors carry out the two-pass regression analysis using the generalized method of moment (GMM) in the first pass and the generalized least squares (GLS) estimation method in the second pass. Findings – The results indicate that the mean-variance CAPM shows a negative risk premium for monthly returns of selected stocks. However, the results for the DR-CAPM of Bawa and Lindenberg (1977) and Harlow and Rao (1989) provide evidence of a positive risk premium for the downside beta. In contrast, the DR-CAPM of Estrada (2002) shows a negative risk premium in some sub-periods while the positive premium in the others. By comparing the risk premium for both downside and upside risks in a single-equation framework, the authors show that the stocks that co-vary with a declining market are compensated with a positive premium for bearing the downside risk. Yet, the risk premium for stocks that are negatively correlated with declining market returns is negative for all the three-downside betas in all the examined sub-periods. Practical implications – The empirical findings of the paper are of great significance for investors for designing effective investment strategies. Specifically, the results help investors to identify an appropriate measure of risk and to construct well-diversified portfolio. The results are also useful for firm managers in capital budgeting decision-making process as they enable them to cost equities appropriately. The results also suggest that the risk-return relationship implied by mean-variance CAPM is negative and therefore this model is not suitable for gauging the risk associated with stocks traded in KSE. Yet, the authors show that DR-CAPM out performs in quantifying the risk premium. Originality/value – Unlike prior empirical studies, the authors follow Estrada’s (2002) suggestions where downside beta is calculated using regression through origin to find correct and unbiased beta. Departing from the existing literature the authors estimate three different versions of DR-CAPM along with the standard CAPM for comparison purpose. Finally, the authors apply sophisticated econometrics methods that help in lessening the problem of non-synchronous trading and the issue of non-normality of returns distribution.

One Central Bank to Rule Them All

Both the U.S. and international stock markets enjoy high returns and Sharpe ratios on days surrounding scheduled FOMC meetings, consistent with global investors demanding a premium to bear risks associated with Federal Reserve decisions. There is no comparable result for other major central banks, whose announcements do not command positive risk premia either globally or, more surprisingly, domestically. Other macroeconomic announcements have impact on local stock markets and, to some extent, even on the U.S. market. The world CAPM explains the cross-section of stock returns during FOMC announcements but not during other central banks' announcements. These findings suggest that the Federal Reserve exerts a unique impact on global equity prices that does not simply stem from the size and importance of the U.S. economy.

Bubbles and Multiple-Factor Asset Pricing Models

This paper derives a multiple-factor asset pricing model with asset price bubbles in an arbitrage-free, competitive, and frictionless market. As such it generalizes existing asset pricing models, all of which implicitly assume asset price bubbles do not exist. This generalization leads to two new empirical implications. The first is that positive alphas can exist in an arbitrage-free market due to the existence of asset price bubbles. These positive alphas do not represent abnormal profit opportunities. The second is that bubble risk factors can exist with positive risk premiums. The testing of these new empirical implications awaits subsequent research.

Ambiguity and Financial Uncertainty in a Real Business Cycle Model

We examine a representative-agent production economy with stochastic mean and volatility of productivity growth, in which the agent has ambiguity aversion and learns about the mean growth state. In recessions, the agent's heightened concern about state uncertainty increases financial uncertainty, measured by the risk-neutral variance of market returns. Consistent with empirical observations, financial uncertainty relates negatively to quantities but positively to volatilities of quantities. Financial uncertainty also leads to lower equity value and carries a positive risk premium. Our calibrated model can closely match moments of quantities and asset returns and also generate a sizable variance risk premium.

What determines the yen swap spread?

We investigate if Japanese yen denominated interest rate swap spreads price risks in addition to liquidity and default risk. These additional risks include: the time-varying correlation between interest rates of different types and maturities; business cycle risk; and market skewness risk. Our analysis, over a number of different maturities and sample periods, supports the existence of an additional risk premium. We also show that the time-varying correlation between short term market interest rates (e.g., TIBOR) and the longer term Government bond yield (e.g., Gensaki) is of particular importance. Japanese yen swap spreads are shown to contain both pro-cyclical and counter-cyclical elements of business cycle risk, positive risk premia for skewness risk and variable risk premia for correlation risk (between fixed and floating interest rates).

Understanding the Sources of Risk Underlying the Cross-Section of Commodity Returns

We show that a model featuring an average commodity factor, a carry factor, and a momentum factor is capable of describing the cross-sectional variation of commodity returns. More parsimonious one- and two-factor models that feature only the average and/or carry factors are rejected. To provide an economic interpretation, we show that innovations in equity volatility can price portfolios formed on carry with a negative risk premium, while innovations in our measure of speculative activity can price portfolios formed on momentum with a positive risk premium. Furthermore, we characterize the relation of the factors with the investment opportunity set.

Cross-Sectional Asset Pricing with Individual Stocks: Betas versus Characteristics

We develop a methodology for estimating bias-corrected premium estimates from cross-sectional regressions of individual stock returns on time-varying conditional betas. For a comprehensive sample of stocks over the sample period from 1951 to 2011, we find evidence of a positive risk premium on the size and momentum factors, but no evidence for the book-to-market and market factors. Firm characteristics explain a much larger proportion of variation in estimated expected returns than factor loadings when return premia are taken to be constant. However, we find evidence of predictability in the premia for characteristics as well as loadings. Taking this into account, surprisingly, the gap between characteristics and loadings narrows (60% versus 35%) for the three-factor model and loadings take the lead (50% to 43%) with the addition of the momentum factor.

Growth uncertainty, generalized disappointment aversion and production-based asset pricing

We study a production economy with regime switching in the conditional mean and volatility of productivity growth. The representative agent has generalized disappointment aversion (GDA) preferences. We show that volatility risk in productivity growth carries a positive and sizable risk premium in levered equity. Our model can endogenously generate long-run risks in the volatility of consumption growth observed in the data. We show that introducing leverage with a procyclical dividend process consistent with the data is critical for the GDA preferences to have a large impact on equity returns.

The forecasting power of medium-term futures contracts

This study investigates whether weekly futures prices, covering the time period 1996-2013, are unbiased predictors of future spot price in the Nordic power market. The results give no clear evidence of bias in the futures prices, except for during the winter period from 2003-2009. In this period the futures prices overshoot the spot price, resulting in a positive risk premium. We find a significant premium during winter and fall when analyzing the whole sample. There is no evidence of a premium during summer. Dividing the sample into two sub periods, 1996-2005 and 2006-2013, we find the highest and most significant risk premium during winter in the first sub period. In the latter period, there is less evidence of a significant risk premium.

Volatility, the Macroeconomy, and Asset Prices

ABSTRACTHow important are volatility fluctuations for asset prices and the macroeconomy? We find that an increase in macroeconomic volatility is associated with an increase in discount rates and a decline in consumption. We develop a framework in which cash flow, discount rate, and volatility risks determine risk premia and show that volatility plays a significant role in explaining the joint dynamics of returns to human capital and equity. Volatility risk carries a sizable positive risk premium and helps account for the cross section of expected returns. Our evidence demonstrates that volatility is important for understanding expected returns and macroeconomic fluctuations.

News Shocks, Long-Run Risk, and Asset Returns

I study the long-run consumption risk reflected in news shock, a shock to expectations about future productivity. I identify news shock using a structural Vector Autoregression analysis. News shocks cause persistent future consumption growth and explain a large share of consumption movements in the long-run. Consistent with the long-run consumption risk hypothesis, I find that news shocks have a significantly positive risk premium in the cross section of asset returns. I also find that news shocks explain the size premium.

Disagreement and asset prices

How do differences of opinion affect asset prices? Do investors earn a risk premium when disagreement arises in the market? Despite their fundamental importance, these questions are among the most controversial issues in finance. In this paper, we use a novel data set that allows us to directly measure the level of disagreement among Wall Street mortgage dealers about prepayment speeds. We examine how disagreement evolves over time and study its effects on expected returns, return volatility, and trading volume in the mortgage-backed security market. We find that increased disagreement is associated with higher expected returns, higher return volatility, and larger trading volume. These results imply that there is a positive risk premium for disagreement in asset prices. We also show that volatility in and of itself does not lead to higher trading volume. Instead, only when disagreement arises in the market is higher uncertainty associated with more trading. Finally, we are able to distinguish empirically between two competing hypotheses regarding how information in markets gets incorporated into asset prices. We find that sophisticated investors appear to update their beliefs through a rational expectations mechanism when disagreement arises.

Wage compensation for risk: The case of Turkey

In this article, I estimate the premium associated with fatal and non-fatal risk within broad industry categories, using official figures provided by the Ministry of Labor and Social Security and wage data from the 2010 and 2011 Household Labor Force Surveys. The results show only positive and significant fatal risk premiums in the manufacturing sector, whereas injury risk premiums exist in both the manufacturing and industry-wide samples. When wage heterogeneity is allowed, fatal risk compensation increases along the distribution, while that of injury risk follows an inverse-u pattern. Compared to similar country cases, the VSL and VSI estimates are relatively small and not significant for low wage earners. Industry averages show that longer working hours are correlated with accidents rates which implies the importance of firm heterogeneity and institutional factors on the high level and variance, particularly for Turkey.

CASH FLOWS, CURRENCY RISK, AND THE COST OF CAPITAL

AbstractCurrency fluctuations can affect firms' cash flows. There is evidence that cash flows are related to a covariance risk factor in global stock markets. Taken together, these two lines of research suggest that the underlying link between currency movements and stock returns may be the cash flow. We test this transmission mechanism with the mimicking portfolio approach. Empirically, we find that our test assets have significant exposure to the currency factor‐mimicking portfolio and this factor carries a significant and positive risk premium.

Why Should You Invest in the BestCompanies to Work For?

This article provides empirical evidence from the capital market that companies operating and competing in the knowledge-based and information-driven economy should be able to enjoy superior benefits and performance by making themselves the best companies to work for. The author analyzes stock risk premiums and risk-adjusted returns on a portfolio of firms ranked consecutively from 1998 to 2011 as the best companies to work for in the United States. The results show that an equal-weighted portfolio of these best companies exhibits positive average risk premiums and average risk-adjusted excess returns a majority of the time. The implication is that if firms take care to make their companies good places to work, it will pay off in the short and long runs, as evidenced from the capital market. Also, it is possible to construct a portfolio of such companies to earn positive average risk premiums and average risk-adjusted excess returns a majority of the time. <b>TOPICS:</b>Security analysis and valuation, portfolio construction, performance measurement

Credit Supply, Financial Distress and the Cross Section of Stock Returns

I present empirical evidence that the TED spread is a priced risk factor in the cross sectional stock returns. Stocks with higher exposure to the change in the TED spread require higher returns, and the return difference between the high sensitivity portfolio and the low sensitivity portfolio is a significant 6.6% annually. Individual stocks within the two extreme TED beta portfolios are more likely to be financially distressed, which is consistent with the documented hump-shaped relationship between expected return and default probability in Garlappi, Tao, and Yan (2008). The TED factor shows enhanced forecasting ability within non-crisis periods, and the size effect shows up only within the group of most distressed firms. This paper uncovers a systematic channel to reconcile the positive risk premium and negative risk premium found within the financially distressed stocks, and provide strong empirical evidence for the effect of credit supplying activities on corporate financing behaviors and stock performances.