These forecasts mimic how an investor could, in real time, combine many firm. Organization capital and the cross section of expected returns andrea l. Eisfeldt and dimitris papanikolaou abstract organization capital is a production factor that is embodied in the rms key talent and has an e ciency that is rm speci c. How average returns change across different stock or portfolios. The resulting predictor can reliably describe the cross section of returns for at least ve years the lower bound of the typical useful life for corporate investments. Retained earningstomarket predicts the cross section of average returns in u.
Takeovers and the crosssection of returns request pdf. We then derive implications for the crosssection of expected returns, and. As a result, both shareholders and management have a claim on the. On the crosssectional relation between expected returns. Out of sample forecasts from fm regressions provide a simple, yet surprisingly effective, way to form a composite trading strategy going long high expected return stocks. Parker princeton university and national bureau of economic research christian julliard princeton university this paper evaluates the central insight of the consumption capital asset pricing model that an assets expected return is determined by its equilibrium risk to.
Competition, productivity, organization and the cross section of. Associate professor of finance department of economics and finance college of business. Eisfeldty ucla dimitris papanikolaouz northwestern university july 2011 abstract organization capital is a production factor that is embodied in the rms key talent and has an e ciency that is rm speci c. Table 7 presents the correlation matrix of the factors used to explain the cross section of equity returns panel a, as well as of the multivariate betas on these factors panel b for the 19812004 period. Abnormal returns normally occur due to announcements from or about the corporation. Abnormal returns are defined as the excess returns of a stock compared to the expected rate of return. Earnings, retained earnings, and booktomarket in the. Information quality and the crosssection of expected returns. A consumptionbased explanation of expected stock returns 541 higher than the eis. Consumption risk and the cross section of expected returns. Many do not view these implications as separate, since either implies the other, but we.
Given this extensive data mining, it does not make sense to use the. Asset pricing hundreds of papers and hundreds of factors attempt to explain the cross section of expected returns. Thus, the dispersion in expected returns arising from heterogeneity in the ratio of organization capital to assets. We nd no statistically reliable premiums on the pro tability and investment factors in the pre1963 sample period, during which the average returns are two tvalue 0. Harvey, liu and zhu 2015 8 made an extensive testing of at least 316 linear factors models to explain the crosssection of expected returns. The results indicate that i the data frequency used to estimate id. French abstract two easily measured variables, size and booktomarket equity, combine to capture the cross sectional variation in average stock returns associated with market 3, size, leverage, booktomarket equity, and earningsprice ratios. 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. Prices crsp monthly files, merged with accounting data from compustat. Portfolio inefficiency and the crosssection of expected returns.
Hence, both shareholders and key talent have a claim to its cash ows. Eisfeldt northwestern university dimitris papanikolaouy northwestern university november 2008 abstract this paper studies the unique risk characteristics of organization capital. How reliable are estimates of expected returns from fm regressions. Idiosyncratic volatility and the cross section of expected. Accounting data, market values, and expected returns worldwide 2 nonlinear equations by numerical methods that may or may not converge, or that may converge to multiple solutions, and, perhaps most saliently, the lack of evidence that iccs, in the cross section, line up well with expected returns easton and monahan, 2005. Consumption risk and the cross section of expected returns jonathan a. My approach exploits the fact that the booktomarket ratio hereafter bm re ects both longterm expected returns and longterm expected pro tabilit. This paper contributes to this line of research by showing, both theoretically and empirically, that the temporal pattern of cash flow as measured by dur has additional explanatory power for. Earnings, retained earnings, and booktomarket in the cross.
Underdiversified investors demand a return compensation for bearing idiosyncratic risk. We provide a novel and relatively simple methodology to obtain expected holding period returns over arbitrary horizons, and we show that our proxies predict the crosssection of future returns up to three years into the future. First, small stocks and value stocks have higher durable consumption betas than big stocks and growth stocks. Although on an individual household level, such a labor hedging demand can be empirically observed e. Earnings, retained earnings, and booktomarket in the cross section of. The crosssection of expected stock returns eugene f. Cross section of expected returns and extreme returns. Book value of equity consists of two main components that we expect contain di er. On the crosssectional relation between expected returns and betas richard roll and stephen a.
Abstract two easily measured variables, size and book. Pdf this paper explores the ability of the capital asset pricing model, as well. Eisfeldty northwestern university dimitris papanikolaouz northwestern university april 2010 abstract this paper studies the unique risk characteristics of organization capital. Pdf the crosssection of expected stock returns researchgate. The cross section of expected stock returns eugene f. Over forty years ago, one of the first tests of the capital asset pricing model capm found that the market beta was a significant explanator of the cross section of expected returns. The cross section of cashflow volatility and expected stock. Over forty years ago, one of the first tests of the capital asset pricing model capm found that the market beta was a significant explanator of the crosssection of expected returns.
If the volatility of the market return is a systematic risk. Pdf crosssectional determinants of expected returns. The cross section of expected stock returns by jonathan lewellen. Moreover, the omk portfolio is uncorrelated with other risk factors such as the market portfolio, size, value or momentum. The first goal of this paper is to provide a systematic investigation of how the stochastic volatility of the market is priced in the cross section of expected stock returns.
Second, the ratio of booktomarket equity and size are found to be the most significant variables that can account for the cross section of expected stock returns. Stocks with relatively high low returns tend to have high low returns every year in the same calendar month. French abstract two easily measured variables, size and booktomarket equity, combine to capture the crosssectional variation in average stock returns associated with market 3, size, leverage, booktomarket equity, and earningsprice ratios. Seasonality in the crosssection of stock returns steven l. Crosssection of expected returns and extreme returns. The point estimates indicate that a one standard deviation change in idiosyncratic risk has between 2. Section 6 investigates the crosssectional asset pricing performance of our model. A labor news hedge portfolio and the crosssection of. There are several advantages of using a cross section of returns on stocks, rather than a cross section of options on the market, to estimate the price of risk of aggregate volatility. Ball 1978 argues that ep is a catchall proxy for unnamed factors in expected returns. Competition, productivity, organization and the cross section. This paper studies the crosssectional properties of return forecasts.
Simply put, the returns on small stocks and value stocks are more procyclical, explaining their high average returns. Thus, they conclude that beta is neither a single relevant risk measure nor a subset of. Assets with greater cash flow exposure to consumption risks should offer higher risk compensation. Harvey, liu and zhu 2015 8 made an extensive testing of at least 316 linear factors models to explain the cross section of expected returns. Outofsample forecasts from fm regressions provide a simple, yet surprisingly effective, way to form a composite trading strategy going long highexpectedreturn stocks.
Two easily measured variables, size and booktomarket equity, combine to capture the crosssectional variation in average stock returns associated with market. The crosssection of expected stock returns and the crosssection of present values abstract realizedreturnscompriseexanteexpectedreturnsplusexpostinnovations,andconsequently both expected returns and returns innovations can be broken down into components re. This provides a theoretical basis for cohen and polks 1998 contention that the value premium is largely an intraindustryphenomenon. These forecasts mimic how an investor could, in real time, combine. Carlson, fisher, and giammarino 2004 also use real options model to study the crosssection of equity returns. Among them are levy 1978, merton 1987, and malkiel and xu 2002. Introduction there is a growing literature documenting a negative relationship between observed volatility and future stock returns. 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. Singapore management university institutional knowledge at. Pdf crosssectional determinants of expected returns we analyze the relation between equity returns, risk, and a rich set of security characteristics.
Takeovers and the crosssection of returns time when future returns are low. Cash flow, consumption risk, and the crosssection of. Mar 01, 2017 we predict that booktomarket strategies work because the retained earnings component of the book value of equity includes the accumulation and, hence, the averaging of past earnings. Consequently, the empirical evidence supporting the capital asset pricing theory is. Consumption, dividends, and the cross section of equity. Eisfeldty northwestern university dimitris papanikolaouz northwestern university september 2009 abstract this paper studies the unique risk characteristics of organization capital. The first goal of this paper is to provide a systematic investigation of how the stochastic volatility of the market is. Using a stock measure of organization capital based on readily available ac.
The crosssection of expected stock returns and the cross. First, we construct a quintilespread portfolio that buys. A consumptionbased explanation of expected stock returns. Most previous stock market anomaly research has focused on one or two return regularities at a timewhether these effects are proxies for one another or whether they are independentwe disentangle returns associated with 25 different anomalies.
Abstract this paper examines the cross sectional relation between idiosyncratic volatility and expected stock returns. Consumption, dividends, and the cross section of equity returns 1643 that cash flow news is an important ingredient governing return news. The crosssection of expected stock returns should then be related to a labor income risk e. 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. This suggests that the standard pricing models do not explain the crosssectional variation in returns across centrality quintiles. Investment and the crosssection of equity returns nyu stern. The cross section of expected holding period returns and. Portfolio inefficiency and the crosssection of expected. In the crosssection, risk and returns are decreasing in productivity. A model of crosssection of equity returns and firm dynamics. But a recent paper by ang, hodrick, xing, and zhang 2006, ahxz hereafter finds that, in the cross section of. Idiosyncratic volatility and the cross section of expected returns turan g. Organization capital and the crosssection of expected returns andrea l.
Hence, stocks with different sensitivities to innovations in aggregate volatility should have different expected returns. Hundreds of papers and hundreds of factors attempt to explain the crosssection of expected returns. The conference will take place at the gleacher center of the booth school of business at the university of chicago. The crosssection of volatility and expected returns. The cross section of expected stock returns 3 available at the time i. What is cross section in cross section of stock return. First, we crosssectionally estimate a price of risk for aggregate market volatility. October 2006 abstract this paper presents a new pattern in the crosssection of expected stock returns. Accounting data, market values, and the cross section of. The crosssection of expected stock returns critical finance. The crosssection of expected stock returns 3 available at the time i. First, when deflated by market values, earnings likely share common economic determinants with. We construct a stock measure of organization capital based on readily available.
Economic risks embodied in cash flows therefore should have a bearing on the risk premia of assets. Using a comprehensive crosssection and timeseries of corporate bond returns assembled from multipledata sources, we analyze whether commonly analyzed equity return predictors also predict bond returns. On the cross sectional relation between expected returns and betas richard roll and stephen a. Ross abstract there is an exact linear relation between expected returns and true betas when the market portfolio is on the ex ante meanvariance efficient frontier, but empirical research has found little relation between sample mean returns and. But a recent paper by ang, hodrick, xing, and zhang 2006, ahxz hereafter finds that, in the crosssection of. We provide a systematic study of how stochastic volatility is priced in the crosssection of expected stock returns.
However, since that time, hundreds of papers have tried to explain the crosssection of expected returns. However, these models typically imply growth options are more risky than assets in place. The economy is made stationary by allowing entry of new firms when existing firms exit. Portfolio inefficiency and the crosssection of expected returns abstract the capital asset pricing model implies that i the market portfolio is efficient and ii expected returns are linearly related to betas. The intuition is that options are replicated by a long position in. Also related to our study is the recent line of literature which has begun to study the prices and risk premiums of the term structure of dividend strips e.
First, using the cross section of returns allows us to create a useful hedging, or mimicking factor portfolio for aggregate volatility risk. Corporate investment and asset price dynamics 2579 pay a twopart adjustment cost, one part fixed and the other proportional to the change in capital, or 4 exercise, at no cost, a onetime abandonment option to discontinue all future operations. They argue that it is a serious mistake to use the. The cross section of cashflow volatility and expected. The remarkable multidimensionality in the crosssection of. However, since that time, hundreds of papers have tried to explain the cross. Crosssectional expected returns and predictability in the korean stock market. Portfolio inefficiency and the cross section of expected returns abstract the capital asset pricing model implies that i the market portfolio is efficient and ii expected returns are linearly related to betas. Competition, productivity, organization and the cross. Two easily measured variables, size and booktomarket equity, combine to capture the crosssectional variation in average stock returns associated with market 3. The role of investor attention and risk preferences. For example, using tenyear rolling estimates of famamacbeth slopes and a crosssectional model with 15. Naive estimates of expected holding period returns can, therefore, lead investors to significantly misallocate capital.
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. Organization capital and the crosssection of expected returns. On the crosssectional relation between expected returns and. First, the correlations among the smb, hml, and takeover factors are fairly high.
1330 1193 1462 1123 876 735 804 1206 1278 1024 24 1166 1616 1658 1154 620 190 1459 481 193 609 666 26 954 1143 485 1092 1016 307 684 932 519 712 33