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Uncertainty and the Dynamics of Multifactor Loadings and Pricing Errors

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  • Carmine Trecroci

    ()
    (University of Brescia)

Abstract

This paper considers an environment where investors have limited knowledge of true systematic risks and therefore continuously re-estimate the forecasting model that they use to form expectations. Based on a parsimonious specification with learning and no conditioning information, I extract time-varying factor loadings, pricing errors, and a measure of pricing uncertainty for the Fama-French three-factor model. Estimated parameters display significant fluctuations over time, both short-run and long-term, along patterns that vary across industry portfolios. Besides being markedly variable across portfolios and over time, abnormal returns and risk loadings also display strong systematic correlations with market conditions and business-cycle developments. Overall, the estimates convey the idea that over the past two decades stocks have experienced a pervasive increase in the variability of their exposure to fundamental risks.

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Bibliographic Info

Article provided by AccessEcon in its journal Economics Bulletin.

Volume (Year): 32 (2012)
Issue (Month): 3 ()
Pages: 2453-2463

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Handle: RePEc:ebl:ecbull:eb-12-00626

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Keywords: Multifactor models; Time-varying alphas; Time-varying betas; Pricing errors;

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  1. Carmine Trecroci, 2010. "How do alphas and betas move? Uncertainty, learning and time variation in risk loadings," Working Papers 1012, University of Brescia, Department of Economics.
  2. Lubos Pastor & Pietro Veronesi, 2009. "Learning in Financial Markets," Annual Review of Financial Economics, Annual Reviews, vol. 1(1), pages 361-381, November.
  3. Andrews, Donald W K, 1991. "Heteroskedasticity and Autocorrelation Consistent Covariance Matrix Estimation," Econometrica, Econometric Society, vol. 59(3), pages 817-58, May.
  4. Lewellen, Jonathan & Nagel, Stefan & Shanken, Jay, 2010. "A skeptical appraisal of asset pricing tests," Journal of Financial Economics, Elsevier, vol. 96(2), pages 175-194, May.
  5. Martin Lettau & Sydney Ludvigson, 2001. "Resurrecting the (C)CAPM: A Cross-Sectional Test When Risk Premia Are Time-Varying," Journal of Political Economy, University of Chicago Press, vol. 109(6), pages 1238-1287, December.
  6. Adrian, Tobias & Franzoni, Francesco, 2009. "Learning about beta: Time-varying factor loadings, expected returns, and the conditional CAPM," Journal of Empirical Finance, Elsevier, vol. 16(4), pages 537-556, September.
  7. Lu Zhang, 2005. "The Value Premium," Journal of Finance, American Finance Association, vol. 60(1), pages 67-103, 02.
  8. Paskalis Glabadanidis, 2009. "A Dynamic Asset Pricing Model with Time-Varying Factor and Idiosyncratic Risk," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 7(3), pages 247-264, Summer.
  9. Andrew Ang & Joseph Chen, 2005. "CAPM Over the Long Run: 1926-2001," NBER Working Papers 11903, National Bureau of Economic Research, Inc.
  10. Lewellen, Jonathan & Nagel, Stefan, 2006. "The conditional CAPM does not explain asset-pricing anomalies," Journal of Financial Economics, Elsevier, vol. 82(2), pages 289-314, November.
  11. Pietro Veronesi & Tano Santos, 2004. "Conditional Betas," 2004 Meeting Papers 24, Society for Economic Dynamics.
  12. Eugene F. Fama & Kenneth R. French, 2006. "The Value Premium and the CAPM," Journal of Finance, American Finance Association, vol. 61(5), pages 2163-2185, October.
  13. Santos, Tano & Veronesi, Pietro, 2010. "Habit formation, the cross section of stock returns and the cash-flow risk puzzle," Journal of Financial Economics, Elsevier, vol. 98(2), pages 385-413, November.
  14. Jostova, Gergana & Philipov, Alexander, 2005. "Bayesian Analysis of Stochastic Betas," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(04), pages 747-778, December.
  15. Tano Santos & Pietro Veronesi, 2004. "Conditional Betas," NBER Working Papers 10413, National Bureau of Economic Research, Inc.
  16. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
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