What Does the Cross-Section Tell About Itself? Explaining Equity Risk Premia with Stock Return Moments

Ilan Cooper; Liang Ma; Paulo Fraga Martins Maio

doi:10.1111/jmcb.12823

What Does the Cross-Section Tell About Itself? Explaining Equity Risk Premia with Stock Return Moments

Ilan Cooper, Liang Ma, Paulo Fraga Martins Maio

Finance, Helsinki

Research output: Contribution to journal › Article › Scientific › peer-review

Abstract

We derive a parsimonious equilibrium three-factor asset pricing model (cross-sectional CAPM, CS-CAPM) in which the realized cross-sectional second and third moments of long-short equity portfolio returns are the driving forces in terms of pricing cross-sectional equity risk premia. Stock market segmentation implies that these two (nonmarket) factors are priced in equilibrium. The three-factor model offers a large fit for the joint cross-sectional risk premia associated with 26 prominent CAPM anomalies, with explanatory ratios around or above 40%. The CS-CAPM compares favorably with multifactor models widely used in the literature. The cross-sectional factors are not subsumed by traditional ICAPM risk factors.

Original language	English
Peer-reviewed scientific journal	Journal of Money, Credit and Banking
Number of pages	46
ISSN	0022-2879
DOIs	https://doi.org/10.1111/jmcb.12823
Publication status	Published - 30.05.2021
MoE publication type	A1 Journal article - refereed

Keywords

512 Business and Management
asset pricing
stock market anomalies
linear multifactor models
CAPM
cross-section of stock returns
realized return variance
realized return skewness
cross-sectional return moments
ICAPM

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abstract = "We derive a parsimonious equilibrium three-factor asset pricing model (cross-sectional CAPM, CS-CAPM) in which the realized cross-sectional second and third moments of long-short equity portfolio returns are the driving forces in terms of pricing cross-sectional equity risk premia. Stock market segmentation implies that these two (nonmarket) factors are priced in equilibrium. The three-factor model offers a large fit for the joint cross-sectional risk premia associated with 26 prominent CAPM anomalies, with explanatory ratios around or above 40%. The CS-CAPM compares favorably with multifactor models widely used in the literature. The cross-sectional factors are not subsumed by traditional ICAPM risk factors.",

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What Does the Cross-Section Tell About Itself? Explaining Equity Risk Premia with Stock Return Moments

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