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Asset pricing at the millennium
 Journal of Finance
"... This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work and on the tradeoff between risk and return. Modern research seeks to understand the behavior of the stochastic discount factor ~SDF! that prices all assets in the economy. The behavior ..."
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Cited by 123 (3 self)
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This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work and on the tradeoff between risk and return. Modern research seeks to understand the behavior of the stochastic discount factor ~SDF! that prices all assets in the economy. The behavior of the term structure of real interest rates restricts the conditional mean of the SDF, whereas patterns of risk premia restrict its conditional volatility and factor structure. Stylized facts about interest rates, aggregate stock prices, and crosssectional patterns in stock returns have stimulated new research on optimal portfolio choice, intertemporal equilibrium models, and behavioral finance. This paper surveys the field of asset pricing. The emphasis is on the interplay between theory and empirical work. Theorists develop models with testable predictions; empirical researchers document “puzzles”—stylized facts that fail to fit established theories—and this stimulates the development of new theories. Such a process is part of the normal development of any science. Asset pricing, like the rest of economics, faces the special challenge that data are generated naturally rather than experimentally, and so researchers cannot control the quantity of data or the random shocks that affect the data. A particularly interesting characteristic of the asset pricing field is that these random shocks are also the subject matter of the theory. As Campbell, Lo, and MacKinlay ~1997, Chap. 1, p. 3! put it: What distinguishes financial economics is the central role that uncertainty plays in both financial theory and its empirical implementation. The starting point for every financial model is the uncertainty facing investors, and the substance of every financial model involves the impact of uncertainty on the behavior of investors and, ultimately, on mar* Department of Economics, Harvard University, Cambridge, Massachusetts
The risk and predictability of international equity returns
 Review of Financial Studies
, 1993
"... We investigate predictability in national equity market returns, and its relation to global economic risks. We show how to consistently estimate the fraction of the predictable variation that is captured by an assetpricing modelfor the expected returns. We use a model in which conditional betas of t ..."
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Cited by 110 (11 self)
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We investigate predictability in national equity market returns, and its relation to global economic risks. We show how to consistently estimate the fraction of the predictable variation that is captured by an assetpricing modelfor the expected returns. We use a model in which conditional betas of the national equity markets depend on local information variables, while global risk premia depend on global variables. We examine singleand multiplebeta models, using monthly data for 1970 to 1989. The models capture much of thepredictability for many countries. Most of this is related to time variation in the global risk premia. We investigate the sources of risk and predictability of international equity market returns. We examine several global economic risk factors, including a world market portfolio, exchange rate fluctuations, meaPart of this research was conducted while the authors were at the University
Characteristics, Covariances, And Average Returns: 1929 To 1997
, 1999
"... The value premium in U.S. stock returns is robust. The positive relation between average return and booktomarket equity is as strong for 1929 to 1963 as for the subsequent period studied in previous papers. A threefactor risk model explains the value premium better than the hypothesis that the bo ..."
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Cited by 101 (6 self)
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The value premium in U.S. stock returns is robust. The positive relation between average return and booktomarket equity is as strong for 1929 to 1963 as for the subsequent period studied in previous papers. A threefactor risk model explains the value premium better than the hypothesis that the booktomarket characteristic is compensated irrespective of risk loadings. Firms with high ratios of book value to the market value of common equity have higher average returns than firms with low booktomarket ratios (Rosenberg, Reid, and Lanstein (1985)). Because the capital asset pricing model (CAPM) of Sharpe (1964) and Lintner (1965) does not explain this pattern in average returns, it is typically called an anomaly. There are four common explanations for the booktomarket (BE/ME) anomaly. One says that the positive relation between BE/ME and average return (the socalled value premium) is a chance result unlikely to be observed out of sample (Black (1993), MacKinlay (1995)). Outofs...
Robust Portfolio Selection Problems
 Mathematics of Operations Research
, 2001
"... In this paper we show how to formulate and solve robust portfolio selection problems. The objective of these robust formulations is to systematically combat the sensitivity of the optimal portfolio to statistical and modeling errors in the estimates of the relevant market parameters. We introduce "u ..."
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Cited by 95 (8 self)
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In this paper we show how to formulate and solve robust portfolio selection problems. The objective of these robust formulations is to systematically combat the sensitivity of the optimal portfolio to statistical and modeling errors in the estimates of the relevant market parameters. We introduce "uncertainty structures" for the market parameters and show that the robust portfolio selection problems corresponding to these uncertainty structures can be reformulated as secondorder cone programs and, therefore, the computational effort required to solve them is comparable to that required for solving convex quadratic programs. Moreover, we show that these uncertainty structures correspond to confidence regions associated with the statistical procedures used to estimate the market parameters. We demonstrate a simple recipe for efficiently computing robust portfolios given raw market data and a desired level of confidence.
Information Costs And Home Bias: An Analysis Of U.s. Holdings Of Foreign . . .
 Journal of International Economics
, 2000
"... : We aim to provide insight into the observed equity home bias phenomenon by analyzing the determinants of U.S. holdings of equities across a wide range of countries. In particular, we explore the role of information costs in determining the country distribution of U.S. investors' equity holdings us ..."
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Cited by 81 (14 self)
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: We aim to provide insight into the observed equity home bias phenomenon by analyzing the determinants of U.S. holdings of equities across a wide range of countries. In particular, we explore the role of information costs in determining the country distribution of U.S. investors' equity holdings using a comprehensive new data set on U.S. ownership of foreign stocks. We find that U.S. holdings of a country's equities are positively related to the share of that country's stock market that is listed on U.S. exchanges, even after controlling for capital controls, trade links, transaction costs, and historical riskadjusted returns. We attribute this finding to the fact that foreign firms that list on U.S. exchanges are obliged to provide standardized, credible financial information, thereby reducing information costs incurred by U.S. investors. This obligation stems from U.S. investor protection regulations, which include stringent disclosure requirements, reconciliation of financial stat...
Risks and Portfolio Decisions involving Hedge Funds
, 2002
"... Hedge funds are known to exhibit nonlinear optionlike exposures to standard asset classes and therefore the traditional linear factor model provides limited help in capturing their riskreturn tradeoffs. We address this problem by augmenting the traditional model with optionbased risk factors. O ..."
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Cited by 81 (6 self)
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Hedge funds are known to exhibit nonlinear optionlike exposures to standard asset classes and therefore the traditional linear factor model provides limited help in capturing their riskreturn tradeoffs. We address this problem by augmenting the traditional model with optionbased risk factors. Our results show that a large number of equityoriented hedge fund strategies exhibit payoffs resembling a short position in a put option on the market index, and therefore bear significant lefttail risk, risk that is ignored by the commonly used meanvariance framework. Using a meanconditional ValueatRisk framework, we demonstrate the extent to which the meanvariance framework underestimates the tail risk. Working with the underlying systematic
Capital markets research in accounting
, 2001
"... I review empirical research on the relation between capital markets and financial statements.The principal sources of demand for capital markets research in accounting are fundamental analysis and valuation, tests of market efficiency, and the role of accounting numbers in contracts and the politica ..."
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Cited by 78 (3 self)
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I review empirical research on the relation between capital markets and financial statements.The principal sources of demand for capital markets research in accounting are fundamental analysis and valuation, tests of market efficiency, and the role of accounting numbers in contracts and the political process.The capital markets research topics of current interest to researchers include tests of market efficiency with respect to accounting information, fundamental analysis, and value relevance of financial reporting.Evidence from research on these topics is likely to be helpful in capital market investment decisions, accounting standard setting, and corporate financial
Comparing asset pricing models: An investment perspective
 Journal of Financial Economics
, 2000
"... We investigate the portfolio choices of meanvarianceoptimizing investors who use sample evidence to update prior beliefs centered on either riskbased or characteristicbased pricing models. With dogmatic beliefs in such models and an unconstrained ratio of position size to capital, optimal portfo ..."
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Cited by 74 (12 self)
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We investigate the portfolio choices of meanvarianceoptimizing investors who use sample evidence to update prior beliefs centered on either riskbased or characteristicbased pricing models. With dogmatic beliefs in such models and an unconstrained ratio of position size to capital, optimal portfolios can differ across models to economically significant degrees. The differences are substantially reduced by modest uncertainty about the models ’ pricing abilities. When the ratio of position size to capital is subject to realistic constraints, the differences in portfolios across models become even less important, nonexistent in some cases.
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 68 (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.
Does fund size erode mutual fund performance? The role of liquidity and organization
, 2003
"... We investigate the effect of scale on performance in the active money management industry. We first document that fund returns, both before and after fees and expenses, decline with lagged fund size, even after adjusting these returns by various performance benchmarks. We then explore a number of p ..."
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Cited by 66 (6 self)
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We investigate the effect of scale on performance in the active money management industry. We first document that fund returns, both before and after fees and expenses, decline with lagged fund size, even after adjusting these returns by various performance benchmarks. We then explore a number of potential explanations for this relationship. We find that this relationship is most pronounced among funds that have to invest in small and illiquid stocks, which suggests that the adverse effects of scale are related to liquidity. Controlling for its size, a fund’s performance actually increases with the asset base of the other funds in the family that the fund belongs to. This suggests that scale need not be bad for fund returns depending on how the fund is organized. Finally, we explore the idea that scale erodes fund performance because of the interaction of liquidity and organizational diseconomies.