IDEAS home Printed from https://ideas.repec.org/a/eee/finlet/v11y2014i3p303-317.html
   My bibliography  Save this article

The value premium, aggregate risk innovations, and average stock returns

Author

Listed:
  • Lindaas, Knut F.
  • Simlai, Prodosh

Abstract

We test whether innovations in aggregate risk, interpolated from a vector autoregressive system that contains the Chen et al. (1986) five factors as in Petkova (2006), are common factors in cross-sectional stock returns. We provide direct evidence that innovation in industrial production growth, a classical business-cycle variable that summarizes the state of the economy, is associated with the cross-sectional return predictability of individual stocks. We conclude that the role of innovation in aggregate risk is not random, and furthermore that it provides guidance concerning an important source of nonfinancial market-based risk in asset returns.

Suggested Citation

  • Lindaas, Knut F. & Simlai, Prodosh, 2014. "The value premium, aggregate risk innovations, and average stock returns," Finance Research Letters, Elsevier, vol. 11(3), pages 303-317.
  • Handle: RePEc:eee:finlet:v:11:y:2014:i:3:p:303-317
    DOI: 10.1016/j.frl.2014.06.001
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1544612314000312
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    2. 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, August.
    3. Ilan Cooper, 2009. "Time-Varying Risk Premiums and the Output Gap," Review of Financial Studies, Society for Financial Studies, vol. 22(7), pages 2601-2633, July.
    4. Aretz, Kevin & Bartram, Söhnke M. & Pope, Peter F., 2010. "Macroeconomic risks and characteristic-based factor models," Journal of Banking & Finance, Elsevier, vol. 34(6), pages 1383-1399, June.
    5. John Y. Campbell & Tuomo Vuolteenaho, 2004. "Inflation Illusion and Stock Prices," American Economic Review, American Economic Association, vol. 94(2), pages 19-23, May.
    6. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
    7. Novy-Marx, Robert, 2013. "The other side of value: The gross profitability premium," Journal of Financial Economics, Elsevier, vol. 108(1), pages 1-28.
    8. Krishnan, C.N.V. & Petkova, Ralitsa & Ritchken, Peter, 2009. "Correlation risk," Journal of Empirical Finance, Elsevier, vol. 16(3), pages 353-367, June.
    9. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
    10. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-1152, September.
    11. Clifford S. Asness & Tobias J. Moskowitz & Lasse Heje Pedersen, 2013. "Value and Momentum Everywhere," Journal of Finance, American Finance Association, vol. 68(3), pages 929-985, June.
    12. Jaewon Choi, 2013. "What Drives the Value Premium?: The Role of Asset Risk and Leverage," Review of Financial Studies, Society for Financial Studies, vol. 26(11), pages 2845-2875.
    13. Shanken, Jay, 1992. "On the Estimation of Beta-Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 5(1), pages 1-33.
    14. Ralitsa Petkova, 2006. "Do the Fama–French Factors Proxy for Innovations in Predictive Variables?," Journal of Finance, American Finance Association, vol. 61(2), pages 581-612, April.
    15. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    16. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-636, May-June.
    17. Martin Lettau, 2001. "Consumption, Aggregate Wealth, and Expected Stock Returns," Journal of Finance, American Finance Association, vol. 56(3), pages 815-849, June.
    18. Fama, Eugene F & French, Kenneth R, 1996. " Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    19. Fama, Eugene F. & French, Kenneth R., 2012. "Size, value, and momentum in international stock returns," Journal of Financial Economics, Elsevier, vol. 105(3), pages 457-472.
    20. Robert F. Engle & Eric Ghysels & Bumjean Sohn, 2013. "Stock Market Volatility and Macroeconomic Fundamentals," The Review of Economics and Statistics, MIT Press, vol. 95(3), pages 776-797, July.
    21. Arshanapalli, Bala & Fabozzi, Frank J. & Nelson, William, 2006. "The value, size, and momentum spread during distressed economic periods," Finance Research Letters, Elsevier, vol. 3(4), pages 244-252, December.
    22. Chen, Nai-Fu & Roll, Richard & Ross, Stephen A, 1986. "Economic Forces and the Stock Market," The Journal of Business, University of Chicago Press, vol. 59(3), pages 383-403, July.
    23. Hwang, Soosung & Rubesam, Alexandre, 2013. "A behavioral explanation of the value anomaly based on time-varying return reversals," Journal of Banking & Finance, Elsevier, vol. 37(7), pages 2367-2377.
    24. Fong, Wai Mun, 2012. "Do expected business conditions explain the value premium?," Journal of Financial Markets, Elsevier, vol. 15(2), pages 181-206.
    25. Guidolin, Massimo & McMillan, David G. & Wohar, Mark E., 2013. "Time varying stock return predictability: Evidence from US sectors," Finance Research Letters, Elsevier, vol. 10(1), pages 34-40.
    26. Jegadeesh, Narasimhan & Titman, Sheridan, 1993. " Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance, American Finance Association, vol. 48(1), pages 65-91, March.
    27. Shanken, Jay & Weinstein, Mark I., 2006. "Economic forces and the stock market revisited," Journal of Empirical Finance, Elsevier, vol. 13(2), pages 129-144, March.
    28. Laura Xiaolei Liu & Lu Zhang, 2008. "Momentum Profits, Factor Pricing, and Macroeconomic Risk," Review of Financial Studies, Society for Financial Studies, vol. 21(6), pages 2417-2448, November.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Chen, Li-Yu & Lai, Jung-Ho & Chang, Shao-Chi, 2017. "The long-term performance of new product introductions," Finance Research Letters, Elsevier, vol. 20(C), pages 162-169.

    More about this item

    Keywords

    Firm size; Book-to-market; Risk innovations; Industrial production growth; Investment opportunity;

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:finlet:v:11:y:2014:i:3:p:303-317. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/frl .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.