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Abstract

The risk premia of linear factor models on economic (non-traded) risk factors can be decomposed into: i) the premium on maximum-correlation portfolios mimicking the factors; ii) (minus) the covariance between the non-traded components of the pricing kernel and the factors; and iii) (minus) the mispricing of the maximum-correlation portfolios. For a given set of assets available for investment, the first component is the same across models and is typically estimated with little bias and high precision. We conclude that the premia on maximum-correlation portfolios are appealing alternatives to the risk premia of linear factor models, with the dividend yield being the only economic factor significantly priced.

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File URL: http://www.sciencedirect.com/science/article/B6VFG-4X8CCX1-2/2/9bc3eab54cc6c5c1b6518a9c03d91e8f
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Bibliographic Info

Article provided by Elsevier in its journal Journal of Empirical Finance.

Volume (Year): 17 (2010)
Issue (Month): 1 (January)
Pages: 54-80

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Handle: RePEc:eee:empfin:v:17:y:2010:i:1:p:54-80

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Web page: http://www.elsevier.com/locate/jempfin

Related research

Keywords: Economic factor Risk premium Pricing kernel Maximum-correlation portfolio;

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References

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Cited by:

1. Lustig, Hanno & van Nieuwerburgh, Stijn & Verdelhan, Adrien, 2012. "The Wealth-Consumption Ratio," CEPR Discussion Papers 9022, C.E.P.R. Discussion Papers.
   
   • Hanno Lustig & Stijn Van Nieuwerburgh & Adrien Verdelhan, 2008. "The Wealth-Consumption Ratio," NBER Working Papers 13896, National Bureau of Economic Research, Inc.
2. Raymond Kan & Cesare Robotti, 2006. "Specification tests of asset pricing models using excess returns," Working Paper 2006-10, Federal Reserve Bank of Atlanta.
   
   • Kan, Raymond & Robotti, Cesare, 2008. "Specification tests of asset pricing models using excess returns," Journal of Empirical Finance, Elsevier, vol. 15(5), pages 816-838, December.

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