IDEAS home Printed from https://ideas.repec.org/a/ucp/jnlbus/v68y1995i3p309-49.html
   My bibliography  Save this article

Do Arbitrage Pricing Models Explain the Predictability of Stock Returns?

Author

Listed:
  • Ferson, Wayne E
  • Korajczyk, Robert A

Abstract

This article studies predictability in U.S. stock returns for multiple investment horizons. The authors measure to what extent predictability is driven by premiums for economywide risk factors, comparing two standard methods for factor selection. They study single-beta models and multiple-beta models. The authors show how to estimate the fraction of the predictability in returns captured by the model simultaneously with the other parameters. Their analysis indicates that the models capture a large fraction of the predictability for all of the investment horizons. The performance of the principal components and the prespecified-factor approaches are broadly similar. Copyright 1995 by University of Chicago Press.

Suggested Citation

  • Ferson, Wayne E & Korajczyk, Robert A, 1995. "Do Arbitrage Pricing Models Explain the Predictability of Stock Returns?," The Journal of Business, University of Chicago Press, vol. 68(3), pages 309-349, July.
  • Handle: RePEc:ucp:jnlbus:v:68:y:1995:i:3:p:309-49
    DOI: 10.1086/296667
    as

    Download full text from publisher

    File URL: http://dx.doi.org/10.1086/296667
    File Function: full text
    Download Restriction: Access to full text is restricted to JSTOR subscribers. See http://www.jstor.org for details.
    ---><---

    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. Fama, Eugene F & French, Kenneth R, 1992. "The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
    2. 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.
    3. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    4. Hansen, Lars Peter, 1982. "Large Sample Properties of Generalized Method of Moments Estimators," Econometrica, Econometric Society, vol. 50(4), pages 1029-1054, July.
    5. Shanken, Jay, 1990. "Intertemporal asset pricing : An Empirical Investigation," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 99-120.
    6. Andrew W. Lo, A. Craig MacKinlay, 1988. "Stock Market Prices do not Follow Random Walks: Evidence from a Simple Specification Test," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 41-66.
    7. Jacob Boudouk & Matthew Richardson, 1994. "The Statistics Of Long‐Horizon Regressions Revisited1," Mathematical Finance, Wiley Blackwell, vol. 4(2), pages 103-119, April.
    8. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-386.
    9. Richardson, Matthew & Stock, James H., 1989. "Drawing inferences from statistics based on multiyear asset returns," Journal of Financial Economics, Elsevier, vol. 25(2), pages 323-348, December.
    10. Goetzmann, William Nelson & Jorion, Philippe, 1993. "Testing the Predictive Power of Dividend Yields," Journal of Finance, American Finance Association, vol. 48(2), pages 663-679, June.
    11. Richardson, Matthew, 1993. "Temporary Components of Stock Prices: A Skeptic's View," Journal of Business & Economic Statistics, American Statistical Association, vol. 11(2), pages 199-207, April.
    12. Kandel, Shmuel & Stambaugh, Robert F, 1990. "Expectations and Volatility of Consumption and Asset Returns," Review of Financial Studies, Society for Financial Studies, vol. 3(2), pages 207-232.
    13. White, Halbert, 1980. "A Heteroskedasticity-Consistent Covariance Matrix Estimator and a Direct Test for Heteroskedasticity," Econometrica, Econometric Society, vol. 48(4), pages 817-838, May.
    14. Ferson, Wayne E, 1989. " Changes in Expected Security Returns, Risk, and the Level of Interest Rates," Journal of Finance, American Finance Association, vol. 44(5), pages 1191-1217, December.
    15. Nelson, Charles R & Kim, Myung J, 1993. "Predictable Stock Returns: The Role of Small Sample Bias," Journal of Finance, American Finance Association, vol. 48(2), pages 641-661, June.
    16. Richardson, Matthew & Smith, Tom, 1991. "Tests of Financial Models in the Presence of Overlapping Observations," Review of Financial Studies, Society for Financial Studies, vol. 4(2), pages 227-254.
    17. Stambaugh, Robert F., 1983. "Arbitrage pricing with information," Journal of Financial Economics, Elsevier, vol. 12(3), pages 357-369, November.
    18. Huberman, Gur & Kandel, Shmuel & Stambaugh, Robert F, 1987. "Mimicking Portfolios and Exact Arbitrage Pricing," Journal of Finance, American Finance Association, vol. 42(1), pages 1-9, March.
    19. Lo, Andrew W & MacKinlay, A Craig, 1990. "Data-Snooping Biases in Tests of Financial Asset Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 3(3), pages 431-467.
    20. Huberman, Gur & Kandel, Shmuel, 1987. "Mean-Variance Spanning," Journal of Finance, American Finance Association, vol. 42(4), pages 873-888, September.
    21. Connor, Gregory, 1984. "A unified beta pricing theory," Journal of Economic Theory, Elsevier, vol. 34(1), pages 13-31, October.
    22. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    23. Fama, Eugene F, 1990. "Stock Returns, Expected Returns, and Real Activity," Journal of Finance, American Finance Association, vol. 45(4), pages 1089-1108, September.
    24. Fama, Eugene F & French, Kenneth R, 1988. "Permanent and Temporary Components of Stock Prices," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 246-273, April.
    25. Douglas T. Breeden & Michael R Gibbons & Robert H. Litzenberger, "undated". "Empirical Tests of the Consumption-Oriented CAPM," Rodney L. White Center for Financial Research Working Papers 07-89, Wharton School Rodney L. White Center for Financial Research.
    26. McCulloch, Robert & Rossi, Peter E., 1990. "Posterior, predictive, and utility-based approaches to testing the arbitrage pricing theory," Journal of Financial Economics, Elsevier, vol. 28(1-2), pages 7-38.
    27. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Review of Financial Studies, Society for Financial Studies, vol. 1(3), pages 195-228.
    28. Ferson, Wayne E & Harvey, Campbell R, 1991. "The Variation of Economic Risk Premiums," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 385-415, April.
    29. Shanken, Jay, 1992. "On the Estimation of Beta-Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 5(1), pages 1-33.
    30. Ferson, Wayne E. & Foerster, Stephen R., 1994. "Finite sample properties of the generalized method of moments in tests of conditional asset pricing models," Journal of Financial Economics, Elsevier, vol. 36(1), pages 29-55, August.
    31. Fama, Eugene F. & Schwert, G. William, 1977. "Asset returns and inflation," Journal of Financial Economics, Elsevier, vol. 5(2), pages 115-146, November.
    32. Harvey, Campbell R. & Zhou, Guofu, 1990. "Bayesian inference in asset pricing tests," Journal of Financial Economics, Elsevier, vol. 26(2), pages 221-254, August.
    33. Bollerslev, Tim & Chou, Ray Y. & Kroner, Kenneth F., 1992. "ARCH modeling in finance : A review of the theory and empirical evidence," Journal of Econometrics, Elsevier, vol. 52(1-2), pages 5-59.
    34. Lehmann, Bruce N. & Modest, David M., 1988. "The empirical foundations of the arbitrage pricing theory," Journal of Financial Economics, Elsevier, vol. 21(2), pages 213-254, September.
    35. 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.
    36. Douglas T. Breeden & Michael R Gibbons & Robert H. Litzenberger, "undated". "Empirical Tests of the Consumption-Oriented CAPM," Rodney L. White Center for Financial Research Working Papers 7-89, Wharton School Rodney L. White Center for Financial Research.
    37. Ferson, Wayne E, 1990. "Are the Latent Variables in Time-Varying Expected Returns Compensation for Consumption Risk?," Journal of Finance, American Finance Association, vol. 45(2), pages 397-429, June.
    38. Foster, F Douglas & Smith, Tom & Whaley, Robert E, 1997. "Assessing Goodness-of-Fit of Asset Pricing Models: The Distribution of the Maximal R-Squared," Journal of Finance, American Finance Association, vol. 52(2), pages 591-607, June.
    39. 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.
    40. Klein, Roger W & Brown, Stephen J, 1984. "Model Selection When There Is "Minimal" Prior Information," Econometrica, Econometric Society, vol. 52(5), pages 1291-1312, September.
    41. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October.
    42. Poterba, James M. & Summers, Lawrence H., 1988. "Mean reversion in stock prices : Evidence and Implications," Journal of Financial Economics, Elsevier, vol. 22(1), pages 27-59, October.
    43. Keim, Donald B., 1983. "Size-related anomalies and stock return seasonality : Further empirical evidence," Journal of Financial Economics, Elsevier, vol. 12(1), pages 13-32, June.
    44. Breeden, Douglas T & Gibbons, Michael R & Litzenberger, Robert H, 1989. " Empirical Tests of the Consumption-Oriented CAPM," Journal of Finance, American Finance Association, vol. 44(2), pages 231-262, June.
    45. Levhari, David & Levy, Haim, 1977. "The Capital Asset Pricing Model and the Investment Horizon," The Review of Economics and Statistics, MIT Press, vol. 59(1), pages 92-104, February.
    46. Connor, Gregory & Korajczyk, Robert A., 1986. "Performance measurement with the arbitrage pricing theory : A new framework for analysis," Journal of Financial Economics, Elsevier, vol. 15(3), pages 373-394, March.
    47. Ferson, Wayne E & Harvey, Campbell R, 1993. "The Risk and Predictability of International Equity Returns," Review of Financial Studies, Society for Financial Studies, vol. 6(3), pages 527-566.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Committee, Nobel Prize, 2013. "Understanding Asset Prices," Nobel Prize in Economics documents 2013-1, Nobel Prize Committee.
    2. Andrew Ang & Geert Bekaert, 2007. "Stock Return Predictability: Is it There?," Review of Financial Studies, Society for Financial Studies, vol. 20(3), pages 651-707.
    3. John Campbell & Jianping Mei, 1993. "Where do Betas Come From? Asset Price Dynamics and the Sources of Systematic Risk," NBER Working Papers 4329, National Bureau of Economic Research, Inc.
    4. J. Annaert & W. Van Hyfte, 2006. "Long-Horizon Mean Reversion for the Brussels Stock Exchange: Evidence for the 19th Century," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 06/376, Ghent University, Faculty of Economics and Business Administration.
    5. Puneet Handa, 2006. "Does Stock Return Predictability Imply Improved Asset Allocation and Performance? Evidence from the U.S. Stock Market (1954–2002)," The Journal of Business, University of Chicago Press, vol. 79(5), pages 2423-2468, September.
    6. Fernando Rubio, 2005. "Eficiencia De Mercado, Administracion De Carteras De Fondos Y Behavioural Finance," Finance 0503028, University Library of Munich, Germany, revised 23 Jul 2005.
    7. Wayne E. Ferson & Andrew F. Siegel & Pisun (Tracy) Xu, 2005. "Mimicking Portfolios with Conditioning Information," NBER Working Papers 11020, National Bureau of Economic Research, Inc.
    8. Cochrane, John H., 2005. "Financial Markets and the Real Economy," Foundations and Trends(R) in Finance, now publishers, vol. 1(1), pages 1-101, July.
    9. João M. Sousa & Ricardo M. Sousa, 2019. "Asset Returns Under Model Uncertainty: Evidence from the Euro Area, the US and the UK," Computational Economics, Springer;Society for Computational Economics, vol. 54(1), pages 139-176, June.
    10. Maio, Paulo & Santa-Clara, Pedro, 2012. "Multifactor models and their consistency with the ICAPM," Journal of Financial Economics, Elsevier, vol. 106(3), pages 586-613.
    11. Frank Weikai Li, 2016. "Macro Disagreement and the Cross-Section of Stock Returns," Review of Asset Pricing Studies, Oxford University Press, vol. 6(1), pages 1-45.
    12. Jacob Boudoukh & Matthew Richardson & Robert F. Whitelaw, 2008. "The Myth of Long-Horizon Predictability," Review of Financial Studies, Society for Financial Studies, vol. 21(4), pages 1577-1605, July.
    13. Li, Yuming, 1998. "Expected stock returns, risk premiums and volatilities of economic factors1," Journal of Empirical Finance, Elsevier, vol. 5(2), pages 69-97, June.
    14. Wayne E. Ferson & Campbell R. Harvey, 1999. "Conditioning Variables and the Cross Section of Stock Returns," Journal of Finance, American Finance Association, vol. 54(4), pages 1325-1360, August.
    15. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
    16. John Y. Campbell, 2000. "Asset Pricing at the Millennium," Journal of Finance, American Finance Association, vol. 55(4), pages 1515-1567, August.
    17. Harvey, Campbell R, 1995. "Predictable Risk and Returns in Emerging Markets," Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 773-816.
    18. Lo, Andrew W. & Mackinlay, A. Craig, 1997. "Maximizing Predictability In The Stock And Bond Markets," Macroeconomic Dynamics, Cambridge University Press, vol. 1(1), pages 102-134, January.
    19. Zura Kakushadze & Willie Yu, 2016. "Multifactor Risk Models and Heterotic CAPM," Papers 1602.04902, arXiv.org, revised Mar 2016.
    20. Zura Kakushadze, 2015. "Heterotic Risk Models," Papers 1508.04883, arXiv.org, revised Jan 2016.

    More about this item

    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:ucp:jnlbus:v:68:y:1995:i:3:p:309-49. 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: (Journals Division). General contact details of provider: https://www.jstor.org/journal/jbusiness .

    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.