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43
Conditional skewness in asset pricing tests
 Journal of Finance
, 2000
"... If asset returns have systematic skewness, expected returns should include rewards for accepting this risk. We formalize this intuition with an asset pricing model that incorporates conditional skewness. Our results show that conditional skewness helps explain the crosssectional variation of expect ..."
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Cited by 157 (6 self)
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If asset returns have systematic skewness, expected returns should include rewards for accepting this risk. We formalize this intuition with an asset pricing model that incorporates conditional skewness. Our results show that conditional skewness helps explain the crosssectional variation of expected returns across assets and is significant even when factors based on size and booktomarket are included. Systematic skewness is economically important and commands a risk premium, on average, of 3.60 percent per year. Our results suggest that the momentum effect is related to systematic skewness. The low expected return momentum portfolios have higher skewness than high expected return portfolios. THE SINGLE FACTOR CAPITAL ASSET PRICING MODEL ~CAPM! of Sharpe ~1964! and Lintner ~1965! has come under recent scrutiny. Tests indicate that the crossasset variation in expected returns cannot be explained by the market beta alone. For example, a growing number of studies show that “fundamental” variables such as size, booktomarket value, and price to earnings ratios
Resurrecting the (C)CAPM: A CrossSectional Test When Risk Premia Are TimeVarying
 Journal of Political Economy
, 2001
"... This paper explores the ability of conditional versions of the CAPM and the consumption CAPM—jointly the (C)CAPM—to explain the cross section of average stock returns. Central to our approach is the use of the log consumption–wealth ratio as a conditioning variable. We demonstrate that such conditio ..."
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Cited by 141 (4 self)
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This paper explores the ability of conditional versions of the CAPM and the consumption CAPM—jointly the (C)CAPM—to explain the cross section of average stock returns. Central to our approach is the use of the log consumption–wealth ratio as a conditioning variable. We demonstrate that such conditional models perform far better than unconditional specifications and about as well as the FamaFrench threefactor model on portfolios sorted by size and booktomarket characteristics. The conditional consumption CAPM can account for the difference in returns between lowbooktomarket and highbooktomarket portfolios and exhibits little evidence of residual size or booktomarket effects. We are grateful to Eugene Fama and Kenneth French for graciously providing the
Predictable Risk and Returns in Emerging Markets
, 1995
"... This article has a number of goals. First, the average or unconditional risk of these equity returns is studied. While previous authors have documented low correlations of the emerging market returns with developed country returns, I test whether adding emerging mar ket assets to the portfolio prob ..."
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Cited by 107 (11 self)
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This article has a number of goals. First, the average or unconditional risk of these equity returns is studied. While previous authors have documented low correlations of the emerging market returns with developed country returns, I test whether adding emerging mar ket assets to the portfolio problem significantly shifts the investment opportunity set. I find that the addition of emerging market assets significantly enhances portfolio opportunities
Conditioning manager alphas on economic information: Another look at the persistence of performance
 Review of Financial Studies
, 1998
"... This article presents evidence on persistence in the relative investment performance of large, institutional equity managers. Similar to existing evidence for mutual funds, we find persistent performance concentrated in the managers with poor priorperiod performance measures. A conditional approach ..."
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Cited by 69 (11 self)
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This article presents evidence on persistence in the relative investment performance of large, institutional equity managers. Similar to existing evidence for mutual funds, we find persistent performance concentrated in the managers with poor priorperiod performance measures. A conditional approach, using timevarying measures of risk and abnormal performance, is better able to detect this persistence and to predict the future performance of the funds than are traditional methods.
Explaining the Poor Performance of Consumptionbased Asset Pricing Models
 Journal of Finance
, 2000
"... We show that the external habitformation model economy of Campbell and Cochrane ~1999! can explain why the Capital Asset Pricing Model ~CAPM! and its extensions are better approximate asset pricing models than is the standard consumptionbased model. The model economy produces timevarying expect ..."
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Cited by 55 (4 self)
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We show that the external habitformation model economy of Campbell and Cochrane ~1999! can explain why the Capital Asset Pricing Model ~CAPM! and its extensions are better approximate asset pricing models than is the standard consumptionbased model. The model economy produces timevarying expected returns, tracked by the dividendprice ratio. Portfoliobased models capture some of this variation in state variables, which a stateindependent function of consumption cannot capture. Therefore, though the consumptionbased model and CAPM are both perfect conditional asset pricing models, the portfoliobased models are better approximate unconditional asset pricing models. THE DEVELOPMENT OF CONSUMPTIONBASED ASSET PRICING THEORY ranks as one of the major advances in financial economics during the last two decades. The classic papers of Lucas ~1978!, Breeden ~1979!, Grossman and Shiller ~1981!, and Hansen and Singleton ~1982, 1983! show how a simple relation between consumption ...
TwoPass Tests of Asset Pricing Models with Useless Factors
, 1997
"... In this paper we investigate the properties of the standard twopass methodology of testing beta pricing models with misspecified factors. In a setting where a factor is useless, defined as being independent of all the asse t returns, we provide theoretical results and simulation evidence that the s ..."
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Cited by 38 (4 self)
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In this paper we investigate the properties of the standard twopass methodology of testing beta pricing models with misspecified factors. In a setting where a factor is useless, defined as being independent of all the asse t returns, we provide theoretical results and simulation evidence that the secondpass crosssectional regression tends to find the beta risk of the useless factor priced more often than it should. More surprisingly, this misspecification bias exacerbates when the number of time series observations increases. Possible ways of detecting useless factors are also examined. When testing asset pricing models relating risk premiums on assets to their betas, the primary question of interest is whether the beta risk of a particular factor is priced (i.e., whether the estimated risk premium associated with a given factor is significantly di#erent from zero). Black, Jensen, and Scholes (1972) and Fama and MacBeth (1973) develop a twopass methodology in which the beta of each asset with respect to a factor is estimated in a firstpass time series regression, and estimated betas are then used in secondpass crosssectional regressions (CSRs) to estimate the risk premium of the factor. This twopass methodology is very intuitive and has been widely used in the literature. The properties of the test statistics and goodnessoffit measures under the twopass methodology are usually developed under the assumptions that the asset pricing model is correctly specified and that the factors are correctly identified. Shanken (1992) provides an excellent discussion of this twopass methodology, especially the large sample properties of the twopass CSR for the correctly specified model under the assumption that returns are conditionally homoskedastic. Jagannathan and Wa...
The Cost of Equity in Emerging Markets: A Downside Risk Approach.” Emerging Markets Quarterly
, 2000
"... Abstract: Recent empirical evidence has established that a measure of downside risk, the semideviation with respect to the mean, explains the cross section of stock returns in emerging markets, and is a plausible variable to be used in a CAPMtype model to compute costs of equity. The evidence repor ..."
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Cited by 20 (5 self)
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Abstract: Recent empirical evidence has established that a measure of downside risk, the semideviation with respect to the mean, explains the cross section of stock returns in emerging markets, and is a plausible variable to be used in a CAPMtype model to compute costs of equity. The evidence reported in this article indicates that the semideviation also explains the cross section of industry returns in emerging markets, thus adding to the robustness of this measure of downside risk. The evidence in this article also shows that, unlike it is the case across emerging markets, across industries in emerging markets beta is correlated to mean returns. Inés Bardají provided valuable research assistance. The views expressed below and any errors that may remain are entirely my own.
Financial Markets and the Real Economy
, 2006
"... I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of “bad times,” rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets’ tendency to pay off poorly in “bad times.” ..."
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Cited by 19 (1 self)
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I survey work on the intersection between macroeconomics and finance. The challenge is to find the right measure of “bad times,” rises in the marginal value of wealth, so that we can understand high average returns or low prices as compensation for assets’ tendency to pay off poorly in “bad times.” I survey the literature, covering the timeseries and crosssectional facts, the equity premium, consumptionbased models, general equilibrium models, and labor income/idiosyncratic risk approaches.
A Skeptical Appraisal of AssetPricing Tests
 Journal of Financial Economics
, 2010
"... Polk, Motohiro Yogo, an anonymous referee, and workshop participants at numerous universities and conferences for their helpful comments. We thank Ken French, Sydney Ludvigson, Stijn Van Nieuwerburgh, and Motohiro Yogo for providing data via their websites. A Skeptical Appraisal of AssetPricing Tes ..."
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Cited by 17 (2 self)
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Polk, Motohiro Yogo, an anonymous referee, and workshop participants at numerous universities and conferences for their helpful comments. We thank Ken French, Sydney Ludvigson, Stijn Van Nieuwerburgh, and Motohiro Yogo for providing data via their websites. A Skeptical Appraisal of AssetPricing Tests It has become standard practice in the crosssectional assetpricing literature to evaluate models based on how well they explain average returns on sizeB/M portfolios, something many models seem to do remarkably well. In this paper, we review and critique the empirical methods used in the literature. We argue that assetpricing tests are often highly misleading, in the sense that apparently strong explanatory power (high crosssectional R 2 s and small pricing errors) in fact provides quite weak support for a model. We offer a number of suggestions for improving empirical tests and evidence that several proposed models don’t work as well as originally advertised
On Selection Biases in BooktoMarket Based Tests of Asset Pricing Models
, 1995
"... Many studies have documented portfolio strategies that provide returns in excess of those expected, given the level of risk of the portfolio. Variables that seem to have predictive power for equity returns include the market capitalization of the firm’s equity and the ratio of the firm’s book equity ..."
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Cited by 15 (0 self)
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Many studies have documented portfolio strategies that provide returns in excess of those expected, given the level of risk of the portfolio. Variables that seem to have predictive power for equity returns include the market capitalization of the firm’s equity and the ratio of the firm’s book equity to market equity (BE/ME). Firms with low market capitalization and high booktomarket values seem to earn high returns. With respect to the booktomarket anomaly, it has been argued that the apparent superior performance is due to a subtle selection bias in a typical data source used to implement the tests of asset pricing models, the COMPUSTAT data. We use a sample of COMPUSTAT data that is free from this bias to investigate whether the previous evidence on the booktomarket anomaly is an artifact of this selection bias. The postulated selection bias does not seem to be important for samples restricted to NYSE/AMEX firms. There is some difference when NASDAQ firms are included in the standard COMPUSTAT sample. This may be due to a truly stronger BE/ME effect or to a more severe selection bias in that sample. Our data do not allow us to disentangle these two possible explanations.