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Risk and the cross section of stock returns

Author

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  • Burlacu, Radu
  • Fontaine, Patrice
  • Jimenez-Garcès, Sonia
  • Seasholes, Mark S.

Abstract

This paper mathematically transforms unobservable rational expectation equilibrium model parameters (information precision and supply uncertainty) into a single variable that is correlated with expected returns and that can be estimated with recently observed data. Our variable can be used to explain the cross section of returns in theoretical, numerical, and empirical analyses. Using Center for Research in Security Prices data, we show that a −1σ to +1σ change in our variable is associated with a 0.31% difference in average returns the following month (equaling 3.78% per annum). The results are statistically significant at the 1% level. Our results remain economically and statistically significant after controlling for stocks' market capitalizations, book-to-market ratios, liquidities, and the probabilities of information-based trading.

Suggested Citation

  • Burlacu, Radu & Fontaine, Patrice & Jimenez-Garcès, Sonia & Seasholes, Mark S., 2012. "Risk and the cross section of stock returns," Journal of Financial Economics, Elsevier, vol. 105(3), pages 511-522.
  • Handle: RePEc:eee:jfinec:v:105:y:2012:i:3:p:511-522
    DOI: 10.1016/j.jfineco.2012.03.008
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    References listed on IDEAS

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    Cited by:

    1. Campbell R. Harvey & Yan Liu & Heqing Zhu, 2014. ". . . and the Cross-Section of Expected Returns," NBER Working Papers 20592, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    Risk premiums; Cross-sectional asset pricing; REE models;

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G1 - Financial Economics - - General Financial Markets
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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