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Intertemporal CAPM with Conditioning Variables

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  • Paulo Maio

    (Hanken School of Economics, 00101 Helsinki, Finland)

Abstract

This paper derives and tests an intertemporal capital asset pricing model (ICAPM) based on a conditional version of the Campbell-Vuolteenaho two-beta ICAPM (bad beta, good beta (BBGB)). The novel factor is a scaled cash-flow factor that results from the interaction between cash-flow news and a lagged state variable (market dividend yield or consumer price index inflation). The cross-sectional tests over 10 portfolios sorted on size, 10 portfolios sorted on book-to-market, and 10 portfolios sorted on momentum show that the scaled ICAPM explains relatively well the dispersion in excess returns on the 30 portfolios. The results for an alternative set of equity portfolios (25 portfolios sorted on size and momentum) show that the scaled ICAPM prices particularly well the momentum portfolios. Moreover, the scaled ICAPM compares favorably with alternative asset pricing models in pricing both sets of equity portfolios. The scaled factor is decisive to account for the dispersion in average excess returns between past winner and past loser stocks. More specifically, past winners are riskier than past losers in times of high price of risk. Therefore, a time-varying cash-flow beta/price of risk provides a rational explanation for momentum. This paper was accepted by Wei Xiong, finance.

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  • Paulo Maio, 2013. "Intertemporal CAPM with Conditioning Variables," Management Science, INFORMS, vol. 59(1), pages 122-141, April.
    • Handle: RePEc:inm:ormnsc:v:59:y:2013:i:1:p:122-141
    DOI: 10.1287/mnsc.1120.1557
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    2. de Oliveira Souza, Thiago, 2016. "The size premium and intertemporal risk," Discussion Papers on Economics 3/2016, University of Southern Denmark, Department of Economics.
    3. Roh, Tai-Yong & Lee, Changjun & Min, Byoung-Kyu, 2019. "Consumption growth predictability and asset prices," Journal of Empirical Finance, Elsevier, vol. 51(C), pages 95-118.
    4. Wenzelburger, Jan, 2020. "Mean-variance analysis and the Modified Market Portfolio," Journal of Economic Dynamics and Control, Elsevier, vol. 111(C).
    5. Maio, Paulo & Xu, Danielle, 2020. "Cash-flow or return predictability at long horizons? The case of earnings yield," Journal of Empirical Finance, Elsevier, vol. 59(C), pages 172-192.
    6. Maio, Paulo, 2013. "Return decomposition and the Intertemporal CAPM," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 4958-4972.
    7. Maio, Paulo, 2016. "Cross-sectional return dispersion and the equity premium," Journal of Financial Markets, Elsevier, vol. 29(C), pages 87-109.
    8. Maio, Paulo & Philip, Dennis, 2015. "Macro variables and the components of stock returns," Journal of Empirical Finance, Elsevier, vol. 33(C), pages 287-308.
    9. Laurinaityte, Nora & Meinerding, Christoph & Schlag, Christian & Thimme, Julian, 2020. "GMM weighting matrices incross-sectional asset pricing tests," Discussion Papers 62/2020, Deutsche Bundesbank.
    10. Stephan Kessler & Bernd Scherer, 2013. "Momentum and macroeconomic state variables," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 27(4), pages 335-363, December.
    11. Rafique, Amir & Iqbal, Khurram & Zakaria, Muhammad & Mujtaba, Ghulam, 2019. "Investigating ICAPM with mean-reverting dynamic conditional correlation: Evidence from an emerging stock exchange," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 525(C), pages 514-523.
    12. Maio, Paulo & Silva, André C., 2020. "Asset pricing implications of money: New evidence," Journal of Banking & Finance, Elsevier, vol. 120(C).
    13. Maio, Paulo & Philip, Dennis, 2018. "Economic activity and momentum profits: Further evidence," Journal of Banking & Finance, Elsevier, vol. 88(C), pages 466-482.

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