In the continuoustime model setup, we can formally identify these. First, we cross sectionally estimate a price of risk for aggregate market volatility. Journal of financial and quantitative analysis, 53 3. Forecast dispersion and the cross section of expected returns timothy c.
Crash sensitivity and the crosssection of expected stock. Evidence of predictable behavior of security returns. July 22, 2011 abstract we examine whether investors get a compensation for holding stocks with a strong sensitivity to extreme market downside movements. Predictability and the crosssection of expected returns. Hundreds of papers and factors attempt to explain the cross section of expected returns. Empirically, historical tail betas help predict the future performance of stocks in extreme market downturns. If aggregate volatility is a risk factor that is orthogonal to existing risk factors, the sensitivity of stocks. Alternative profitability measures and cross section of. Hodrick, yuhang xing, and xiaoyan zhang nber working paper no. Forecasts based on longer histories of fm slopes work best and, statistically, are quite strongly related to subsequent annual returns. Idiosyncratic risk and the crosssection of stock returns. Outofsample forecasts from fm regressions provide a simple, yet surprisingly effective, way to form a composite trading strategy going long high expected return stocks. Nov 10, 2014 this paper studies the implications of this decomposition for the cross.
Given this extensive data mining, it does not make any economic or statistical sense to use the usual significance criteria for a newly discovered factor, e. Individual stocks expected return estimates are a key input for equity selection models. A new factor model consisting of the market factor, an investment factor, and a return onequity factor is a good start to understanding the crosssection of expected stock returns. Option returns and the crosssectional predictability of implied volatility. We recognize the annual cross sectional autocorrelation pattern documented in jegadeesh 1990. French abstract two easily measured variables, size and booktomarket equity, combine to capture the cross sectional variation in average stock returns associated with market 3, size, leverage, booktomarket equity, and earningsprice ratios. Alessio saretto the krannert school of management purdue university november 2005 abstract i study the crosssection of realized stock option returns and. We document a robust finding that firms with high eig have larger future investment growth and earn significantly higher returns than firms with low eig, which cannot be fully explained by leading factor models. The history of the cross section of stock returns juhani t. Option returns and the crosssectional predictability of. Request pdf trends in the crosssection of expected stock returns we examine recent shifts in crosssectional return predictability for a comprehensive sample of nyseamex and nasdaq stocks. Ball 1978 argues that ep is a catchall proxy for unnamed factors in expected returns. Crash aversion and the crosssection of expected stock. Hundreds of papers and hundreds of factors attempt to explain the cross section of expected returns.
Ep is likely to be higher prices are lower relative to earnings for stocks with higher risks and expected returns, whatever the unnamed sources of risk. The cross section of expected stock returns 429 also possible, however, that beme just captures the unraveling regression toward the mean of irrational market whims about the prospects of firms. We use copulas to measure such lower tail dependence. A new factor model consisting of the market factor, an investment factor, and a returnonequity factor is a good start to understanding the cross section of expected stock returns. Section 1 describes the database used in this study. Abstractin this paper we investigate the explanatory power of the market beta, firm size, and the booktomarket ratio, as well as valueatrisk regarding the crosssectional expected stock returns in a less developed stock market taiwans stock market. Abstract two easily measured variables, size and book. Second, the ratio of booktomarket equity and size are found to be the most significant variables that can account for the cross section of expected stock returns. The empirical analysis reveals that the log accounting ratios capture cross. Section 2 examines the empirical relationships between idiosyncratic risk, liquidity and stock returns.
Worldwide, stocks with strong crash sensitivity deliver average returns of more than. The crosssection of volatility and expected returns. The predictions translate into a high value added for investors. This paper presents a new pattern in the cross section of expected stock returns.
Crash sensitivity and the crosssection of expected stock returns abstract this paper examines whether investors receive compensation for holding crashsensitive stocks. We propose a measure of corporate investment plans, namely, the expected investment growth eig. This paper provides an extensive international analysis of the cross sectional return predictive power of a variety of firmlevel profitability measures, calculated from different combinations of three important measures of earnings gross profit, operating income, and ebit and four scaling variables enterprise value, book value of assets, market value of equity, and book value of. Two easily measured variables, size me and booktomarket equity. Cross section of volatility and expected returns 261 of assets that may have different exposures to aggregate volatility and hence different average returns. Given this extensive data mining, it does not make sense to use the usual criteria for establishing. We test for the presence of a systematic tail risk premium in the cross section of expected returns by applying a measure of the sensitivity of assets to extreme market downturns, the tail beta. Continuous beta, discontinuous beta, and the crosssection of expected stock returns sophia zhengzi liy job market paper this version. Crash sensitivity and crosssection of expected stock returns. Section 3 analyzes each factors out of sample performance. The cross section of expected stock returns revisited. Trends in the crosssection of expected stock returns. My results suggest that crosssectional regressions provide quite reliable estimates of expected returnsindeed, the estimates appear to be much more reliable than prior work has found for the implied cost of capital, though a direct. They find that two other variables, size market equity and booktomarket equity, combine to capture the cross sectional variation in average stock returns during the same period.
January 15, 20 abstract aggregate stock market returns are naturally categorized as either small or large movements. The cross section of expected stock returns by jonathan lewellen. Given that so many papers have attempted to explain the same crosssection of expected returns, statistical inference should not be based on a single test perspective. Media coverage and the cross section of stock returns lily fang and joel peress forthcoming in the journal of finance abstract by reaching a broad population of investors, mass media can alleviate informational frictions and. The crosssection of expected stock returns 5 the fm slopes. Crash aversion and the cross section of expected stock returns worldwide abstract this paper examines whether investors receive compensation for holding stocks with a strong sensitivity to extreme market downturns in a sample covering forty countries. Seasonality in the crosssection of stock returns sciencedirect. Using annual accounting data and monthly returns from compustat no delisting returns utilities and financials included 30% and 70% breakpoints based on nyse firms 0 0. We treat expected returns as latent variables and apply the partial least squares pls estimator that filters them out from the characteristics under an assumption that the characteristics are linked to expected returns through one or few common latent factors. However, since that time, hundreds of papers have tried to explain the cross. The crosssection of expected stock returns eugene f. Systematic tail risk journal of financial and quantitative. The negative relation between idiosyncratic volatility and expected returns, or idiosyncratic volatility puzzle, exists only for stocks with high max, implying that the puzzle may arise from the overpayment for stocks with high max and the subsequent return reversal.
Discussions on the driving forces behind the patterns observed in the stock market an extensive set of results that serve as a reference for practitioners and academics alike numerous references to both contemporary and foundational research articles empirical asset. The cross section of volatility and expected returns andrew ang, robert j. Green the editor and to the referee for valuable expositional advice. A new factor model consisting of the market factor, an investment factor, and a returnonequity factor is a good start to understanding the crosssection of expected stock returns. Var and the crosssection of expected stock returns. Forecast dispersion and the crosssection of expected returns. Accounting data, market values, and the cross section of expected. Thus, they conclude that beta is neither a single relevant risk measure nor a subset of. Jstors terms and conditions of use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or. Learning about distress and predictability in heterogeneous orchards. Extreme dependence structures and the crosssection of. This paper presents a new pattern in the crosssection of expected stock returns. The crosssection of expected stock returns critical finance.
Aggregation of information about the cross section of stock. Our goal is to provide guidance as to the appropriate significance level using a multiple testing framework. Whatever the underlying economic causes, our main result is straightfor ward. These forecasts mimic how an investor could, in real time, combine many firm characteristics to obtain a composite estimate of a stocks expected return. Roberts june 2017 draft abstract using data spanning the 20th century, we show that the majority of accountingbased return anomalies, including investment and pro tability, are most likely an artifact of data snooping. The cross section of expected stock returns by jonathan. Crash sensitivity and the crosssection of expected stock returns. Crash sensitivity and the cross section of expected stock returns abstract this paper examines whether investors receive compensation for holding crashsensitive stocks. These forecasts mimic how an investor could, in real time, combine many firm characteristics to obtain a composite estimate of a stock s expected return. Stocks tend to have relatively high or low returns every year in the same calendar month. G12, g abstract we examine the pricing of aggregate volatility risk in the cross section of stock returns. We also find that learning helps to generate more realistic dispersion of cross sectional expected returns, relative to pure aggregate consumption risk models with complete information and disaster risk. This paper studies the cross sectional properties of return forecasts derived from famamacbeth regressions.
Stocks tend to have relatively high or low returns every year in the same. We find that stocks with no media coverage earn higher returns than stocks with high media coverage even after controlling for well. Accounting data, market values, and the cross section of. Sep 28, 2009 we investigate this hypothesis by studying the cross.
Earnings, retained earnings, and booktomarket in the cross. Media coverage and the crosssection of stock returns. Complementing the widely used conventional multiple regression approach which can suffer from overfitting with a large number of predictors we propose a combination lasso classo approach to improve outofsample forecasts of crosssectional expected stock returns via shrinkage. The cross section of expected stock returns 3 available at the time i. Firm characteristics and expected stock returns by yufeng han. Extreme dependence structures and the cross section of expected stock returns stefan ruenzi and florian weigert this version.
We capture the crash sensitivity of stocks by their lower tail dependence ltd with the market based on copulas. The crosssection of expected stock returns econpapers. Accounting data, market values, and expected returns worldwide 2 nonlinear equations by numerical methods that may or may not converge, or that may converge to multiple solutions, and, perhaps most saliently, the lack of evidence that iccs, in the cross section, line up well with expected returns easton and monahan, 2005. Idiosyncratic risk and the cross section of stock returns whether average idiosyncratic volatility has recently risen, whether it is a good predictor for aggregate market returns and whether it has a positive relationship with expected returns in the cross section are still matters of active debate. A 2008 study by eugene fama and kenneth french found evidence that past changes in book equity and price contain independent information about expected cash flows that can be used to improve estimates of expected returns. When we estimate the spanning tests post and pre1990, we find that retained earningstomarket subsumes the. I am grateful to christopher malloy and andrew jackson for thoughtful comments and suggestions. Booktomarket and the crosssection of expected returns in. Citeseerx the crosssection of expected stock returns. Fama and french 1993 show that, when size is controlled for, market beta does not explain the cross sectional variation in returns for the 19631990 period. French, title the crosssection of expected stock returns, journal journal of.
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