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Productivity-based asset pricing: Theory and evidence

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  • Balvers, Ronald J.
  • Huang, Dayong

Abstract

This paper considers asset pricing from the production side. It differs from earlier approaches to production-based asset pricing in that the pricing kernel is derived by replacing the marginal rate of intertemporal substitution with an amended version of the marginal rate of intertemporal transformation in a complete markets economy. Relying on a general version of the traditional Real Business Cycle macro model we find that the variables determining the mean returns of all financial assets are the productivity shock as the sole factor together with the capital stock and lagged Solow residual (productivity level) as conditioning variables. Standard GMM estimation finds that our model improves on the complementary consumption-based and market-based approaches and is competitive with the Fama-French three-factor model. The model explains the size premium from differences in the unconditional sensitivity to productivity shocks—small firms are more sensitive to productivity shocks—and explains the value premium from differences in the conditional sensitivity to productivity shocks—growth stocks are more sensitive to productivity shocks in good states when the risk premium is low.
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  • Balvers, Ronald J. & Huang, Dayong, 2007. "Productivity-based asset pricing: Theory and evidence," Journal of Financial Economics, Elsevier, vol. 86(2), pages 405-445, November.
  • Handle: RePEc:eee:jfinec:v:86:y:2007:i:2:p:405-445
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    Cited by:

    1. Balvers, Ronald J. & Huang, Dayong, 2009. "Evaluation of linear asset pricing models by implied portfolio performance," Journal of Banking & Finance, Elsevier, vol. 33(9), pages 1586-1596, September.
    2. Kizys, Renatas & Pierdzioch, Christian, 2011. "The changing sensitivity of realized portfolio betas to U.S. output growth: An analysis based on real-time data," Journal of Economics and Business, Elsevier, vol. 63(3), pages 168-186, May.
    3. Szymon Grabowski, 2007. "Real economic activity and state of financial markets," Working Papers 7, Department of Applied Econometrics, Warsaw School of Economics.
    4. Yu Chen & Thomas Cosimano & Alex Himonas & Peter Kelly, 2014. "An Analytic Approach for Stochastic Differential Utility for Endowment and Production Economies," Computational Economics, Springer;Society for Computational Economics, vol. 44(4), pages 397-443, December.
    5. Belo, Frederico, 2010. "Production-based measures of risk for asset pricing," Journal of Monetary Economics, Elsevier, vol. 57(2), pages 146-163, March.
    6. Du, Ding & Hu, Ou, 2014. "The long-run component of foreign exchange volatility and stock returns," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 31(C), pages 268-284.
    7. Balvers, Ronald & Du, Ding & Zhao, Xiaobing, 2017. "Temperature shocks and the cost of equity capital: Implications for climate change perceptions," Journal of Banking & Finance, Elsevier, vol. 77(C), pages 18-34.
    8. Yi-Cheng Shih & Sheng-Syan Chen & Cheng-Few Lee & Po-Jung Chen, 2014. "The evolution of capital asset pricing models," Review of Quantitative Finance and Accounting, Springer, vol. 42(3), pages 415-448, April.
    9. repec:eee:finmar:v:36:y:2017:i:c:p:76-90 is not listed on IDEAS
    10. 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.
    11. Sanglim Lee, 2012. "Expected Currency Excess Returns and International Business Cycles," Working papers 2012-16, University of Connecticut, Department of Economics.
    12. Gomez Biscarri, Javier & Lopez Espinosa, German, 2008. "The influence of differences in accounting standards on empirical pricing models: An application to the Fama-French model," Journal of Multinational Financial Management, Elsevier, vol. 18(4), pages 369-388, October.
    13. Pithak Srisuksai & Vimut Vanitcharearntham, 2016. "Asset Pricing with Idiosyncratic Shocks," Applied Economics Journal, Kasetsart University, Faculty of Economics, Center for Applied Economic Research, vol. 23(1), pages 35-58, June.
    14. Lu Zhang, 2017. "The Investment CAPM," NBER Working Papers 23226, National Bureau of Economic Research, Inc.
    15. Massimiliano Croce, Mariano, 2014. "Long-run productivity risk: A new hope for production-based asset pricing?," Journal of Monetary Economics, Elsevier, vol. 66(C), pages 13-31.
    16. Balvers, Ronald & Du, Ding & Zhao, Xiaobing, 2012. "The Adverse Impact of Gradual Temperature Change on Capital Investment," 2012 Annual Meeting, August 12-14, 2012, Seattle, Washington 124676, Agricultural and Applied Economics Association.
    17. Hsu, Po-Hsuan & Huang, Dayong, 2010. "Technology prospects and the cross-section of stock returns," Journal of Empirical Finance, Elsevier, vol. 17(1), pages 39-53, January.
    18. Ron Balvers & Ding Du & Xiaobing Zhao, 2009. "What Do Financial Markets Reveal about Global Warming?," Working Papers 09-04, Department of Economics, West Virginia University.
    19. Huang, Dayong & Wang, Fang, 2009. "Cash, investments and asset returns," Journal of Banking & Finance, Elsevier, vol. 33(12), pages 2301-2311, December.

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