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An Intertemporal CAPM with Stochastic Volatility

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  • John Y. Campbell
  • Stefano Giglio
  • Christopher Polk
  • Robert Turley

Abstract

This paper extends the approximate closed-form intertemporal capital asset pricing model of Campbell (1993) to allow for stochastic volatility. The return on the aggregate stock market is modeled as one element of a vector autoregressive (VAR) system, and the volatility of all shocks to the VAR is another element of the system. Our estimates of this VAR reveal novel low-frequency movements in market volatility tied to the default spread. We show that growth stocks underperform value stocks because they hedge two types of deterioration in investment opportunities: declining expected stock returns, and increasing volatility.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18411.

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Date of creation: Sep 2012
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Handle: RePEc:nbr:nberwo:18411

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References

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  1. Laurent E. Calvet & Adlai J. Fisher, 2005. "Multifrequency News and Stock Returns," NBER Working Papers 11441, National Bureau of Economic Research, Inc.
  2. Torben G. Andersen & Tim Bollerslev & Francis X. Diebold & Paul Labys, 2001. "Modeling and Forecasting Realized Volatility," NBER Working Papers 8160, National Bureau of Economic Research, Inc.
  3. John Y. Campbell, 1995. "Understanding Risk and Return," Harvard Institute of Economic Research Working Papers 1711, Harvard - Institute of Economic Research.
  4. Ole E. Barndorff-Nielsen & Shephard, 2002. "Econometric analysis of realized volatility and its use in estimating stochastic volatility models," Journal of the Royal Statistical Society Series B, Royal Statistical Society, vol. 64(2), pages 253-280.
  5. Tim Bollerslev, 1986. "Generalized autoregressive conditional heteroskedasticity," EERI Research Paper Series EERI RP 1986/01, Economics and Econometrics Research Institute (EERI), Brussels.
  6. Bansal, Ravi & Kiku, Dana & Yaron, Amir, 2012. "An Empirical Evaluation of the Long-Run Risks Model for Asset Prices," Critical Finance Review, now publishers, now publishers, vol. 1(1), pages 183-221, January.
  7. Campbell, John, 1987. "Stock Returns and the Term Structure," Scholarly Articles 3207699, Harvard University Department of Economics.
  8. Jason Beeler & John Y. Campbell, 2009. "The Long-Run Risks Model and Aggregate Asset Prices: An Empirical Assessment," NBER Working Papers 14788, National Bureau of Economic Research, Inc.
  9. Black, Fischer, 1972. "Capital Market Equilibrium with Restricted Borrowing," The Journal of Business, University of Chicago Press, vol. 45(3), pages 444-55, July.
  10. John Y. Campbell, 1992. "Intertemporal Asset Pricing Without Consumption Data," NBER Working Papers 3989, National Bureau of Economic Research, Inc.
  11. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
  12. Baillie, Richard T. & Bollerslev, Tim & Mikkelsen, Hans Ole, 1996. "Fractionally integrated generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 74(1), pages 3-30, September.
  13. Bollerslev, Tim & Ole Mikkelsen, Hans, 1996. "Modeling and pricing long memory in stock market volatility," Journal of Econometrics, Elsevier, vol. 73(1), pages 151-184, July.
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Citations

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Cited by:
  1. Tim Bollerslev & Lai Xu & Hao Zhou, 2012. "Stock Return and Cash Flow Predictability: The Role of Volatility Risk," CREATES Research Papers 2012-51, School of Economics and Management, University of Aarhus.
  2. Dong Lou & Christopher Polk, . "Inferring Arbitrage Activity from Return Correlations," FMG Discussion Papers dp721, Financial Markets Group.
  3. Larry G. Epstein & Shaolin Ji, 2013. "Ambiguous volatility and asset pricing in continuous time," Papers 1301.4614, arXiv.org.
  4. Nikolai Roussanov, 2010. "Composition of Wealth, Conditioning Information, and the Cross-Section of Stock Returns," NBER Working Papers 16073, National Bureau of Economic Research, Inc.
  5. Turan G. Bali & Hao Zhou, 2013. "Risk, Uncertainty, and Expected Returns," Koç University-TUSIAD Economic Research Forum Working Papers, Koc University-TUSIAD Economic Research Forum 1306, Koc University-TUSIAD Economic Research Forum.
  6. : Constantinos Antonio & : John A. Doukas & : Avanidhar Subrahmanyam, 2013. "Investor Sentiment and Beta Pricing," Working Papers, Warwick Business School, Finance Group wpn13-05, Warwick Business School, Finance Group.
  7. Song, Zhaogang & Xiu, Dacheng, 2014. "A Tale of Two Option Markets: Pricing Kernels and Volatility Risk," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2014-58, Board of Governors of the Federal Reserve System (U.S.).
  8. Marcelo Ochoa, 2013. "Volatility, labor heterogeneity and asset prices," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2013-71, Board of Governors of the Federal Reserve System (U.S.).
  9. Claudio Morana, 2013. "Insights on the global macro-finance interface: Structural sources of risk factors fluctuations and the cross-section of expected stock returns," Working Papers, University of Milano-Bicocca, Department of Economics 264, University of Milano-Bicocca, Department of Economics, revised Dec 2013.
  10. Maio, Paulo, 2013. "Return decomposition and the Intertemporal CAPM," Journal of Banking & Finance, Elsevier, vol. 37(12), pages 4958-4972.
  11. Committee, Nobel Prize, 2013. "Understanding Asset Prices," Nobel Prize in Economics documents, Nobel Prize Committee 2013-1, Nobel Prize Committee.

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