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109
Assessing asset pricing anomalies
 Review of Financial Studies
, 2001
"... The optimal portfolio strategy is developed for an investor who has detected an asset pricing anomaly but is not certain that the anomaly is genuine rather than merely apparent. The analysis takes account of the fact that the parameters of both the underlying asset pricing model and the anomalous re ..."
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Cited by 28 (2 self)
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The optimal portfolio strategy is developed for an investor who has detected an asset pricing anomaly but is not certain that the anomaly is genuine rather than merely apparent. The analysis takes account of the fact that the parameters of both the underlying asset pricing model and the anomalous returns are estimated rather than known. The value that an investor would place on the ability to invest to exploit the apparent anomaly is also derived and illustrative calculations are presented for the FamaFrench SMB and HML portfolios, whose returns are anomalous relative to the CAPM. An asset pricing anomaly is a statistically significant difference between the realized average returns associated with certain characteristics of securities, or on portfolios of securities formed on the basis of those characteristics, and the returns that are predicted by a particular asset pricing model. What is anomalous with respect to one model may be consistent with the predictions of other asset pricing models. For example, an excess return associated with a security’s dividend yield is anomalous with respect to the basic Capital Asset Pricing Model but is consistent with extensions that incorporate investor taxes. Some anomalies are inconsistent with any known rational asset pricing model; they appear to represent “money left on the table”; such examples include the
Explaining the crosssection of stock returns in Japan: Factors or characteristics
 Journal of Finance
, 2001
"... Japanese stock returns are even more closely related to their booktomarket ratios than are their U.S. counterparts, and thus provide a good setting for testing whether the return premia associated with these characteristics arise because the characteristics are proxies for covariance with priced f ..."
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Cited by 23 (1 self)
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Japanese stock returns are even more closely related to their booktomarket ratios than are their U.S. counterparts, and thus provide a good setting for testing whether the return premia associated with these characteristics arise because the characteristics are proxies for covariance with priced factors. Our tests, which replicate the Daniel and Titman ~1997! tests on a Japanese sample, reject the Fama and French ~1993! threefactor model, but fail to reject the characteristic model. FINANCIAL ECONOMISTS HAVE EXTENSIVELY STUDIED the crosssectional determinants of U.S. stock returns, and contrary to theoretical predictions, find very little crosssectional relation between average stock returns and systematic risk measured either by market betas or consumption betas. In contrast, the crosssectional patterns of stock returns are closely associated with characteristics like booktomarket ratios, capitalizations, and stock return momentum. 1 More recent research on the crosssectional patterns of stock returns documents size, booktomarket, and momentum in most developed countries.
Stochastic risk premiums, stochastic skewness in currency options, and stochastic discount factors in international economies
 Journal of Financial Economics
, 2007
"... We develop models of stochastic discount factors in international economies that produce stochastic risk premiums and stochastic skewness in currency options. We estimate the models using timeseries returns and option prices on three currency pairs that form a triangular relation. Estimation shows ..."
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Cited by 19 (1 self)
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We develop models of stochastic discount factors in international economies that produce stochastic risk premiums and stochastic skewness in currency options. We estimate the models using timeseries returns and option prices on three currency pairs that form a triangular relation. Estimation shows that the average risk premium in Japan is larger than that in the US or the UK, the global risk premium is more persistent and volatile than the countryspecific risk premiums, and investors respond differently to different shocks. We also identify highfrequency jumps in each economy, but find that only downside jumps are priced. Finally, our analysis shows that the risk premiums are economically compatible with movements in stock and bond market fundamentals.
A Shrinkage Approach to Model Uncertainty and Asset Allocation,” working paper
, 2002
"... This paper takes a shrinkage approach to examine empirical implications of aversion to model uncertainty. The shrinkage approach explicitly shows how predictive distributions incorporate data and prior beliefs. It enables us to solve the optimal portfolio for uncertaintyaverse investors. Aversion t ..."
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Cited by 14 (0 self)
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This paper takes a shrinkage approach to examine empirical implications of aversion to model uncertainty. The shrinkage approach explicitly shows how predictive distributions incorporate data and prior beliefs. It enables us to solve the optimal portfolio for uncertaintyaverse investors. Aversion to uncertainty about the CAPM leads investors to hold a portfolio that is not meanvariance efficient for predictive distributions. However, meanvariance efficient portfolios corresponding to extremely strong beliefs in the FamaFrench model are approximately optimal for uncertaintyaverse investors. The empirical Bayes approach does not deliver optimal portfolios when investors are averse to uncertainty. The diversified world market portfolio is optimal for uncertaintyaverse investors, and U.S. investors ’ home bias is robust to the belief or disbelief in the world CAPM.
VALUE VERSUS GLAMOUR
"... The fragility of the CAPM has led to a resurgence of research that frequently uses trading strategies based on sorting procedures to uncover relations between firm characteristics (such as “value ” or “glamour”) and equity returns. We examine the propensity of these strategies to generate statistic ..."
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Cited by 10 (0 self)
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The fragility of the CAPM has led to a resurgence of research that frequently uses trading strategies based on sorting procedures to uncover relations between firm characteristics (such as “value ” or “glamour”) and equity returns. We examine the propensity of these strategies to generate statistically and economically significant profits due to our familiarity with the data. Under plausible assumptions, datasnooping can account for up to 50 percent of the insample relations between firm characteristics and returns uncovered using single (oneway) sorts. The biases can be much larger if we simultaneously condition returns on two (or more) characteristics.
Operating Leverage, Stock Market Cyclicality and the CrossSection of Returns
, 2004
"... I use a puttyclay technology to explain several asset market facts. The key mechanism is as follows: a one percent increase in revenues leads to a morethanone percent increase in profits, since labor costs don’t move oneforone. This amplification is greater for plants with low productivity for ..."
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Cited by 7 (1 self)
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I use a puttyclay technology to explain several asset market facts. The key mechanism is as follows: a one percent increase in revenues leads to a morethanone percent increase in profits, since labor costs don’t move oneforone. This amplification is greater for plants with low productivity for which the average profit margin (revenue minus costs) is small. This “operating leverage ” effect implies that low productivity plants benefit disproportionately from business cycle booms. These plants have thus higher systematic risk and higher average returns. This model can help explain the empirical findings of Fama and French (1992), and more generally the sources of differences in market betas across firms. I obtain supporting evidence for the mechanism using firm and industrylevel data. The aggregate effect follows from trend growth: lowproductivity plants outnumber highproductivity plants, making the aggregate stock market procyclical. I examine these aggregate implications and find that this model generates a volatile stock market return that predicts the business cycle.
Value and momentum everywhere
, 2009
"... Value and momentum ubiquitously generate abnormal returns for individual stocks within several countries, across country equity indices, government bonds, currencies, and commodities. We study jointly the global returns to value and momentum and explore their common factor structure. We find that va ..."
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Cited by 6 (0 self)
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Value and momentum ubiquitously generate abnormal returns for individual stocks within several countries, across country equity indices, government bonds, currencies, and commodities. We study jointly the global returns to value and momentum and explore their common factor structure. We find that value (momentum) in one asset class is positively correlated with value (momentum) in other asset classes, and value and momentum are negatively correlated within and across asset classes. Liquidity risk is positively related to value and negatively to momentum, and its importance increases over time, particularly following the liquidity crisis of 1998. These patterns emerge from the power of examining value and momentum everywhere simultaneously and are not easily detectable when examining each asset class in isolation.
Has The CrossSection of Average Returns Always Been the Same? Evidence from Germany, 18811913
, 2000
"... The crosssection of average annual returns on German common stock in the period of 18811913 exhibits several of the patterns that have been observed in more recent U.S. data. Market beta is hardly important, and its explanatory power is swamped by size and the ratio of book value to market value. ..."
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Cited by 5 (0 self)
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The crosssection of average annual returns on German common stock in the period of 18811913 exhibits several of the patterns that have been observed in more recent U.S. data. Market beta is hardly important, and its explanatory power is swamped by size and the ratio of book value to market value. A booktomarket risk measure #covariance with a portfolio long in high booktomarket #rms and short in low booktomarket #rms# has no e#ect on the explanatory power of the booktomarket characteristic. But the size e#ect appears to be caused by selection bias in the sample. And the booktomarket e#ect is opposite that of the recent U.S. experience #and, hence, can certainly not be attributed to selection bias#. Finally, a momentum portfolio constructed on the basis of the error of the basic 3characteristic model #market beta, size and booktomarket# does not generate signi#cant returns. These #ndings highlight the variability in the power of certain characteristics in explaining the c...
Is the Value Premium a Proxy for TimeVarying Investment Opportunities: Some Time Series Evidence, Unpublished Working Paper, the Federal Reserve Bank of St. Louis
, 2005
"... City for useful comments and discussion. We also thank Ken French for making the data available through his website. Jason Higbee provided excellent research assistance. The views expressed in this paper are those of the authors and do not necessarily reflect the official positions of the Federal Re ..."
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Cited by 5 (3 self)
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City for useful comments and discussion. We also thank Ken French for making the data available through his website. Jason Higbee provided excellent research assistance. The views expressed in this paper are those of the authors and do not necessarily reflect the official positions of the Federal Reserve Bank of St. Louis or the Federal Reserve System. Is the Value Premium a Proxy for TimeVarying Investment Opportunities: Some TimeSeries Evidence We uncover a positive stock market riskreturn tradeoff after controlling for the covariance of market returns with the value premium. Fama and French (1996) conjecture that the value premium proxies for investment opportunities; therefore, by ignoring it, early specifications suffer from an omitted variable problem that causes a downward bias in the riskreturn tradeoff estimation. We also document a positive relation between the value premium and its conditional variance, and the estimated conditional value premium is strongly countercyclical. The latter evidence supports the view that value is riskier than growth in bad times, when the price of risk is high.
An Adaptive Model On Asset Pricing And Wealth Dynamics With Heterogeneous Trading Strategies
, 2002
"... This paper develops an adaptive model on asset pricing and wealth dynamic of a financial market with heterogeneous agents and examines the profitability of momentum and contrarian trading strategies. In order to characterize asset price, wealth dynamics and rational adaptiveness arising from the int ..."
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Cited by 4 (0 self)
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This paper develops an adaptive model on asset pricing and wealth dynamic of a financial market with heterogeneous agents and examines the profitability of momentum and contrarian trading strategies. In order to characterize asset price, wealth dynamics and rational adaptiveness arising from the interaction of heterogeneous agents with CRRA utility, an adaptive discrete time equilibrium model in terms of return and wealth proportions (among heterogeneous representative agents) is established.