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Long-Run Cash-Flow and Discount-Rate Risks in the Cross-Section of US Returns

  • Michail Koubouros

    (Department of Economics University of Peloponnese)

  • Dimitrios Malliaropulos

    (Department of Banking and Financial Management University of Piraeus and EFG-Eurobank)

  • Ekaterini Panopoulou

    (Department of Economics National University of Ireland Maynooth)

This paper decomposes the overall market beta of common stocks into four parts reflecting uncertainty related to the long-run dynamics of stock- specific and market-wide cash flows and discount rates. We employ a discrete time version of Merton’s Intertemporal CAPM to test whether these four sources of risk command different risk prices. The model performs well in pricing average returns on single- and double-sorted portfolios according to size, book-to-market, dividend-price ratios and past risk. It generates high estimates for the explained cross-sectional variation in average returns, lower average pricing errors than the Fama-French three factor model and economically and statistically acceptable estimates for the coefficient of relative risk aversion.

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File URL: http://econwpa.repec.org/eps/fin/papers/0503/0503014.pdf
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Paper provided by EconWPA in its series Finance with number 0503014.

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Length: 42 pages
Date of creation: 11 Mar 2005
Date of revision: 17 Jan 2006
Handle: RePEc:wpa:wuwpfi:0503014
Note: Type of Document - pdf; pages: 42
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
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  3. George CHACKO & Luis M. VICEIRA, 1999. "Dynamic Consumption and Portfolio Choice with Stochastic Volatility in Incomplete Markets," FAME Research Paper Series rp11, International Center for Financial Asset Management and Engineering.
  4. John Y. Campbell & Tuomo Vuolteenaho, 2003. "Bad Beta, Good Beta," NBER Working Papers 9509, National Bureau of Economic Research, Inc.
  5. Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-65, June.
  6. John Y. Campbell, 2002. "Consumption-Based Asset Pricing," Harvard Institute of Economic Research Working Papers 1974, Harvard - Institute of Economic Research.
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  8. 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.
  9. John Y. Campbell & Robert J. Shiller, 1988. "Stock Prices, Earnings and Expected Dividends," Cowles Foundation Discussion Papers 858, Cowles Foundation for Research in Economics, Yale University.
  10. Campbell, John Y, 1996. "Understanding Risk and Return," Journal of Political Economy, University of Chicago Press, vol. 104(2), pages 298-345, April.
  11. McQueen, Grant & Pinegar, Michael & Thorley, Steven, 1996. " Delayed Reaction to Good News and the Cross-Autocorrelation of Portfolio Returns," Journal of Finance, American Finance Association, vol. 51(3), pages 889-919, July.
  12. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  13. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
  14. 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.
  15. Daniel, Kent & Titman, Sheridan, 1997. " Evidence on the Characteristics of Cross Sectional Variation in Stock Returns," Journal of Finance, American Finance Association, vol. 52(1), pages 1-33, March.
  16. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 25(1), pages 23-49, November.
  17. Epstein, Larry G & Zin, Stanley E, 1991. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: An Empirical Analysis," Journal of Political Economy, University of Chicago Press, vol. 99(2), pages 263-86, April.
  18. Dimson, Elroy, 1979. "Risk measurement when shares are subject to infrequent trading," Journal of Financial Economics, Elsevier, vol. 7(2), pages 197-226, June.
  19. John Y. Campbell, 1990. "A Variance Decomposition for Stock Returns," NBER Working Papers 3246, National Bureau of Economic Research, Inc.
  20. Eugene F. Fama & Kenneth R. French, 2004. "The Capital Asset Pricing Model: Theory and Evidence," Journal of Economic Perspectives, American Economic Association, vol. 18(3), pages 25-46, Summer.
  21. Epstein, Larry G & Zin, Stanley E, 1989. "Substitution, Risk Aversion, and the Temporal Behavior of Consumption and Asset Returns: A Theoretical Framework," Econometrica, Econometric Society, vol. 57(4), pages 937-69, July.
  22. Scholes, Myron & Williams, Joseph, 1977. "Estimating betas from nonsynchronous data," Journal of Financial Economics, Elsevier, vol. 5(3), pages 309-327, December.
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