Predictability and the Cross-Section of Expected Returns: A Challenge for Asset Pricing Models
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Date
2021-01-22
Author
Schlag, Christian
Semenischev, Michael
Thimme, Julian
SAFE No.
289
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Abstract
"Many modern macro finance models imply that excess returns on arbitrary assets are predictable via the price-dividend ratio and the variance risk premium of the aggregate stock market. We propose a simple empirical test for the ability of such a model to explain the cross-section of expected returns by sorting stocks based on the sensitivity of expected returns to these quantities. Models with only one uncertainty-related state variable, like the habit model or the long-run risks model, cannot pass this test. However, even extensions with more state variables mostly fail. We derive criteria models have to satisfy to produce expected return patterns in line with the data and discuss various examples."
Research Area
Financial Markets
Keywords
asset pricing, cross-section of stock returns, predictability
JEL Classification
G12, E44, D81
Research Data
Topic
Macro Finance
Consumption
Saving and Borrowing
Consumption
Saving and Borrowing
Relations
1
Publication Type
Working Paper
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- LIF-SAFE Working Papers [334]