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

Ilan Cooper, Liang Ma, Paulo Fraga Martins Maio

Research output: Contribution to journalArticleScientificpeer-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 languageEnglish
Peer-reviewed scientific journalJournal of Money, Credit and Banking
Number of pages46
ISSN0022-2879
DOIs
Publication statusPublished - 30.05.2021
MoE publication typeA1 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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