Empirical Asset Pricing: Classes 5 & 6: The Cross-Section of Expected Stock Returns
Empirical Asset Pricing: Classes 5 & 6: The Cross-Section of Expected Stock Returns
Empirical Asset Pricing: Classes 5 & 6: The Cross-Section of Expected Stock Returns
Jun Pan
Unlike the market portfolio, the Size and Value portfolios are empirically motivated.
If we think of them as risk premiums, then we need to understand the real,
macroeconomic, aggregate, nondiversifiable risk that is proxied by the SMB and
HML portfolios.
In particular, why are investors so concerned about holding stocks that do badly
when the SMB and HML portfolios do badly, even though the market does not fall?
We know that small stocks are riskier because they have higher betas. The reward
demanded for holding small stocks, however, is larger than what can be justified by
the CAPM. Similarly, after controlling for the CAPM, why do investors still consider
value stocks risky and demand an additional premium?
We care because there are prevalent usages of size and value as risk factors. Index
funds and ETFs are being offered based on the three factor model. Nevertheless, we
know very little about the nature of these factors: Are they risk factors? If so, what
risk? If not, then what are they?
SAIF 交大高金 Jun Pan 潘军 November 18, 2019 2 / 24
Explanations from Various Camps
Rational Camp: HML and SMB contain information above and beyond that in the
market return for forecasting GDP growth. Proxies for variables that forecast
time-varying investment opportunities or time-varying risk aversion.
The Behavioral Camp: Expectational errors made by investors.
The Critics: Survival bias and Data snooping
20
15
Noise (bps)
'87 Crash
9/11 LEH
Fed
rate LTCM
hike
10 dotcom
UK peak
currency BSC
crisis
Asia
MEX BSC
Peso hedge
funds
5
GM/Ford
FIRREA
RTC
0
1985 1990 1995 2000 2005 2010 2015 2020
std (%) GBP EUR AUD CAD CNY INR JPY CHF THB RUB
0.60 0.63 0.82 0.59 0.10 0.38 0.64 0.70 0.36 0.77
corr (%) GBP EUR AUD CAD CNY INR JPY CHF THB RUB
GBP 64.4 53.1 45.3 12.9 25.2 12.3 49.7 18.6 23.9
EUR 64.4 55.3 46.0 10.4 23.3 27.5 78.2 21.1 25.7
AUD 53.1 55.3 62.3 12.8 33.9 2.9 39.2 23.4 32.8
CAD 45.3 46.0 62.3 9.4 27.0 1.0 32.7 19.9 33.3
CNY 12.9 10.4 12.8 9.4 16.8 5.6 8.8 16.1 10.7
INR 25.2 23.3 33.9 27.0 16.8 -4.0 15.1 25.5 26.6
JPY 12.3 27.5 2.9 1.0 5.6 -4.0 37.5 17.6 -1.1
CHF 49.7 78.2 39.2 32.7 8.8 15.1 37.5 17.7 19.3
THB 18.6 21.1 23.4 19.9 16.1 25.5 17.6 17.7 15.9
RUB 23.9 25.7 32.8 33.3 10.7 26.6 -1.1 19.3 15.9