Asset Pricing: Cross-section of Returns
Sunday, Jan. 5, 2020 8:00 AM - 10:00 AM (PDT)
- Chair: Serhiy Kozak, University of Maryland
Estimating the Anomaly Baserate
AbstractThe academic literature contains literally hundreds of variables that seem to predict the cross-section of expected returns. This so-called `anomaly zoo' has caused many to question whether researchers are using the right tests for statistical significance. But, here's the thing: even if a researcher is using the right tests, he will still be drawing the wrong conclusions from his analysis if he is starting out with the wrong priors---i.e., if he is starting out with incorrect beliefs about the ex ante probability of discovering a tradable anomaly prior to seeing any test results. So, what are the right priors to start out with? What is the correct anomaly baserate? We propose a new statistical approach to answer this question. The key insight is that, under certain conditions, there's a one-to-one mapping between the ex ante probability of discovering a tradable anomaly and the best-fit tuning parameter in a penalized regression. When we apply our new statistical approach to the cross-section of monthly returns, we find that the anomaly baserate has fluctuated substantially since the start of our sample in May 1973. The ex ante probability of discovering a tradable anomaly was much higher in 2003 than in 1990. As a proof of concept, we construct a trading strategy that invests in previously discovered predictors and show that adjusting this strategy to account for the prevailing anomaly baserate boosts its performance.
Operating Hedge and Gross Profitability Premium
AbstractIn this paper we explore the hedging effect induced by variable costs in production, and its impact on fundamental risk of firm cash flows and stock returns. The hedging effect varies across firms and is weaker for more profitable firms. This leads to more profitable firms having a higher exposure to aggregate profitability shocks, giving rise to a gross profitability premium. Our model captures coexistence of the negatively correlated gross profitability and value factors, addressing an empirical pattern that poses a challenge to the models relying on operating leverage as the primary source of the value premium.
The Short Duration Premium
AbstractStocks of firms with cash flows concentrated in the short-term (i.e., short duration stocks) pay a large premium over long duration stocks. I empirically demonstrate this premium: (i) is long-lived and strong even among large firms; (ii) subsumes the value and profitability premia; and (iii) exposes investors to variation in expected returns, especially in times when the premium is high. These facts are consistent with an intertemporal model in which the marginal (long-term) investor dislikes expected return declines as they lead to lower expected wealth growth. The model also captures the positive relation between risk premia and bond duration.
- G1 - General Financial Markets