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Cash-Flow Risk, Discount Risk, and the Value Premium

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Author Info
Tano Santos
Pietro Veronesi
Abstract

A habit persistence, general equilibrium model with multiple assets matches both the time series properties of the market portfolio and the cross-sectional predictability of returns on price sorted portfolios, the value premium. Consistent with empirical evidence, the model shows that (a) value stocks are those with higher cash-flow risk; (b) the size of the value premium is larger in %u201Cbad times,%u201D due to time variation in risk preferences; (c) the unconditional CAPM fails, because of general equilibrium restrictions on the market portfolio. The dynamic nature of the value premium rationalizes why the conditional CAPM and a Fama and French (1993) HML factor outperform the unconditional CAPM.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11816.

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Date of creation: Dec 2005
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Handle: RePEc:nbr:nberwo:11816

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G12 - Financial Economics - - General Financial Markets - - - Asset Pricing

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