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Can An ”Estimation Factor” Help Explain Cross-Sectional Returns?

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  • Lundtofte, Frederik

    ()
    (Department of Economics, Lund University)

Abstract

We show in a theoretical model that the expected excess return on any asset depends on its covariance not only with the market portfolio, but also with changes in the representative agent’s estimate. In the empirical specification, this ”estimation factor” is based on realized growth in aggregate dividends and earnings. We test our model by using GMM and compare it to the Fama-French model. The results suggest that the estimation factor is priced. Moreover, the Hansen-Jagannathan distances show that the conditional and static versions of our derived model perform on a par with the corresponding versions of the Fama-French model.

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Bibliographic Info

Paper provided by Lund University, Department of Economics in its series Working Papers with number 2005:18.

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Length: 32 pages
Date of creation: 24 Feb 2005
Date of revision:
Publication status: Published in Journal of Business, Finance and Accounting, 2009, pages 705-724.
Handle: RePEc:hhs:lunewp:2005_018

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Postal: Department of Economics, School of Economics and Management, Lund University, Box 7082, S-220 07 Lund,Sweden
Phone: +46 +46 222 0000
Fax: +46 +46 2224613
Web page: http://www.nek.lu.se/en
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Keywords: learning; incomplete information; equilibrium; factor pricing models;

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  1. Campbell, John, 1987. "Stock Returns and the Term Structure," Scholarly Articles 3207699, Harvard University Department of Economics.
  2. Vassalou, Maria, 2003. "News related to future GDP growth as a risk factor in equity returns," Journal of Financial Economics, Elsevier, vol. 68(1), pages 47-73, April.
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  4. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
  5. Lars Peter Hansen & Ravi Jagannathan, 1994. "Assessing specification errors in stochastic discount factor models," Staff Report 167, Federal Reserve Bank of Minneapolis.
  6. Fama, Eugene F., 1984. "The information in the term structure," Journal of Financial Economics, Elsevier, vol. 13(4), pages 509-528, December.
  7. Ravi Jagannathan & Zhenyu Wang, 1996. "The conditional CAPM and the cross-section of expected returns," Staff Report 208, Federal Reserve Bank of Minneapolis.
  8. Klein, Roger W. & Bawa, Vijay S., 1976. "The effect of estimation risk on optimal portfolio choice," Journal of Financial Economics, Elsevier, vol. 3(3), pages 215-231, June.
  9. Campbell, John & Shiller, Robert, 1988. "Stock Prices, Earnings, and Expected Dividends," Scholarly Articles 3224293, Harvard University Department of Economics.
  10. Pietro Veronesi, . "How Does Information Quality Affect Stock Returns?," CRSP working papers 462, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  11. Hansen, Lars Peter & Singleton, Kenneth J, 1982. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models," Econometrica, Econometric Society, vol. 50(5), pages 1269-86, September.
  12. Massa, Massimo & Simonov, Andrei, 2005. "Is learning a dimension of risk?," Journal of Banking & Finance, Elsevier, vol. 29(10), pages 2605-2632, October.
  13. Pietro Veronesi, 2000. "How Does Information Quality Affect Stock Returns?," Journal of Finance, American Finance Association, vol. 55(2), pages 807-837, 04.
  14. Michael J. Brennan & Ashley W. Wang & Yihong Xia, 2004. "Estimation and Test of a Simple Model of Intertemporal Capital Asset Pricing," Journal of Finance, American Finance Association, vol. 59(4), pages 1743-1776, 08.
  15. Pietro Veronesi, . "How Does Information Quality Affect Stock Returns?," CRSP working papers 361, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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