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Cash-Flow Risk, Discount Risk, and the Value Premium

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  • Tano Santos
  • Pietro Veronesi

Abstract

A habit persistence, general equilibrium model with multiple assets matches both the time series properties of the market portfolio and the cross-sectional predictability of returns on price sorted portfolios, the value premium. Consistent with empirical evidence, the model shows that (a) value stocks are those with higher cash-flow risk; (b) the size of the value premium is larger in "bad times," due to time variation in risk preferences; (c) the unconditional CAPM fails, because of general equilibrium restrictions on the market portfolio. The dynamic nature of the value premium rationalizes why the conditional CAPM and a Fama and French (1993) HML factor outperform the unconditional CAPM.

Suggested Citation

  • Tano Santos & Pietro Veronesi, 2005. "Cash-Flow Risk, Discount Risk, and the Value Premium," NBER Working Papers 11816, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:11816
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    References listed on IDEAS

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    2. Lars Peter Hansen, 2007. "Beliefs, Doubts and Learning: Valuing Economic Risk," NBER Working Papers 12948, National Bureau of Economic Research, Inc.

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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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