Dynamic Risk Factors and An Intertemporal Capital Asset Pricing

This paper proposes an interest rate model of dynamic risk factors and examines the returns of inter–temporal capital assets. The nominal pricing kernel is built on a yield-surface of federal bonds, inflation rates and market indexes. The beta values of derivative or portfolio in the system are determined by finding correlations between asset returns and pricing kernel innovations from data. We present the calibrations of capital asset returns to the market data with the numerical fitting. The model is tested using market return, short rate, inflation, term spread and produces the cross-sectional evidence that the value stocks have higher loadings on the cash-flow and discount-rate shocks than do growth stocks. We infer the discount-rate shocks and the cash-flow shocks, and find that the value stocks are riskier than the growth ones on the measurement of volatility shocks, which verifies and supports the asset return decomposition.