Questions tagged [asset-pricing]

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Testing one asset pricing model against another a la Cochrane via change in $\hat\alpha' \text{cov}(\hat\alpha,\hat\alpha')^{-1}\hat\alpha$

I am reading section section 14.6 of John Cochrane's lectures notes for the course Business 35150 Advanced Investments. On p. 239-240, he discusses testing one asset pricing model against another. ...
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Scaling variables (Fraction vs % vs log) when regressing twelve month returns

Dear Stack community, My question is the following; If my dependent variable is twelve month returns. And as independent variables I have fiscal year variables like ROA and log variables like the log ...
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Testing one asset pricing model against another a la Cochrane: why this works

I am reading section section 14.6 of John Cochrane's lectures notes for the course Business 35150 Advanced Investments. On p. 239-240, he discusses testing one asset pricing model against another. I ...
Richard Hardy's user avatar
1 vote
1 answer
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Does including an additional pricing factor necessarily reduce the pricing errors?

I am reading section section 14.6 of John Cochrane's lectures notes for the course Business 35150 Advanced Investments. On p. 239-240, he discusses testing one asset pricing model against another. ...
Richard Hardy's user avatar
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Testing one asset pricing model against another a la Cochrane: a counterexample

I am reading section section 14.6 of John Cochrane's lectures notes for the course Business 35150 Advanced Investments. On p. 239-240, he discusses testing one asset pricing model against another. I ...
Richard Hardy's user avatar
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Power-utility function for calculating Certainty equivalent

I have a question regarding how i should calculate 3.2-3.4, currently studying for an exam. What i don't get is how to acctually derive the certainty equivalent from the expected utility of gross ...
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2 answers
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Testing as in Fama & MacBeth vs. comparing models as in Cochrane's lecture notes

Testing a model against its extension as in Fama & MacBeth (1973) Fama & MacBeth (1973) tested the CAPM against an alternative that the dependence between the expected excess return $E(r_{i,t}^...
Richard Hardy's user avatar
3 votes
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Understanding the Intersection of "Advances in Financial Machine Learning" and "Asset Pricing in Stock Market Prediction"

I have been reading "Advances in Financial Machine Learning" by Marcos Lopez de Prado and "Machine Learning in Asset Pricing" by Stefan Nagel, and I noticed that there seems to be ...
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French and Fama - Alpha vs Residuals (Error)

When running a regression to empirically test models like CAPM or the Fama and French Model, why do we test the statistical significance of the intercept? Do we ignore the residual error? Why not ...
Lusitano's user avatar
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Shanken's correction for Fama-MacBeth (1973) generalization of the CAPM

Fama & MacBeth (1973) tested the CAPM against an alternative that the dependence between the expected excess return $E(r_{i,t}^∗)$ and the relative systematic risk $\beta_𝑖$ is nonlinear (namely, ...
Richard Hardy's user avatar
2 votes
1 answer
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What quantities (means, betas) must be constant over time for the GRS test to be valid?

I am interested in testing the CAPM using the GRS test. Consider $N$ assets observed for $T$ time periods. Using the notation of Cochrane "Asset Pricing" (2005), the GRS test amounts to ...
Richard Hardy's user avatar
3 votes
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106 views

Arbitrage Opportunities in a Two-Zero Coupon Bond Market

Question: Suppose we are in a market where there are only two zero coupon bonds, both with a face value of 100: the first one with a maturity of one year and a price of 90, and the second one with a ...
Roberto Palermo's user avatar
2 votes
1 answer
85 views

Question about the footnote in page 33 of the Asset Pricing and Portfolio Choice Theory by Kerry E. Back

The following question is from Kerry E. Back's textbook, and I struggle with it many days, but I wonder this question could be trivial for expertises. If anyone can help, I will really apreciate it! ...
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How to get a Certain Consumption Equivalent using Epstein-Zin preferences?

In many asset pricing models we use CRRA preferences and Epstein-Zin preferences. Let's say I have an agent that lives $T$ periods with CRRA preferences: $$ V_0 = \sum_{t=0}^{T} \beta^t \frac{C_t^{1-\...
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Complete two-period model with specific replication strategy

Find a complete two-period model in which the unique replication strategy of a call (with a suitably chosen strike) shorts the stock in the first period (i.e. the call price falls if the stock rises ...
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Complete market without risk-neutral measure

Let $\mathcal{M}$ be a one-period model with $\Omega=\{\omega_1,\omega_2\}$ and $S_t^0=1$ for $t=0,1$. Find a $D$ such that $S^d$, $d=1,...,D$ yields a complete market without a risk-neutral measure. ...
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Counterexample for the Second fundamental theorem of Asset Pricing

so the The Second Fundamental Theorem of Asset Pricing says: An arbitrage-free market (S,B) consisting of a collection of stocks S and a risk-free bond B is complete if and only if there exists a ...
Analysis's user avatar
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How to calculate the discount rate from yield when adequate price data does not exist [closed]

I'm creating a pricing model for an asset that is similar to a bond, for which I need a discount rate. Using yield to calculate this discount rate was my first thought, but this seems impossible for ...
user68199's user avatar
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188 views

Principal Portfolios Prediction Matrix estimation (Bryan Kelly)

I have recently discovered Bryan Kelly's paper on Principal Portfolios (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3623983) and had some doubts about the prediction matrix $\Pi$. He defines $\...
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GRS test does not reject a scalar multiple of the market factor

I have been playing with the GRS test (see my R script below) in relation to Why not use a time series regression when the factor is not a return?. I generated a $10,000\times 26$ matrix of returns on ...
Richard Hardy's user avatar
2 votes
1 answer
131 views

GRS test does not reject a nonsense factor in place of the market factor

I have been playing with the GRS test (see my R script below) in relation to Why not use a time series regression when the factor is not a return?. I generated a $630\times 26$ matrix of returns on 25 ...
Richard Hardy's user avatar
1 vote
0 answers
71 views

Understanding mean-variance tautology from Roll's critique

One of the points of Roll's critique (Roll, 1977) can be summarized as follows (quoting Wikipedia): Mean-variance tautology: Any mean-variance efficient portfolio $R_{p}$ satisfies the CAPM equation ...
Richard Hardy's user avatar
6 votes
2 answers
433 views

Why not use a time series regression when the factor is not a return?

I am trying to wrap my head around the statement that time series regression should not be used for testing a factor model when the factor is not a return. This has been mentioned in multiple posts, ...
Richard Hardy's user avatar
3 votes
1 answer
100 views

Nominal vs. real (inflation-adjusted) prices/returns in cross-sectional asset pricing

I have the impression that asset pricing models such as the CAPM or Fama & French 3 factor model typically concern nominal rather than real (inflation-adjusted) prices/returns. If this is indeed ...
Richard Hardy's user avatar
6 votes
0 answers
209 views

Testing asset pricing models with Roll's critique in mind

Roll's critique (Roll, 1977) can be summarized as follows (quoting Wikipedia): Mean-variance tautology: Any mean-variance efficient portfolio $R_{p}$ satisfies the CAPM equation exactly: $$ E(R_{i})-...
Richard Hardy's user avatar
2 votes
0 answers
49 views

Benchmark Model for Path-Dependant Monte Carlo Simulations?

As part of my research for my masters thesis, I'm testing out the effectiveness of some different models in Monte Carlo simulations for path dependant options. I will be attempting a model-free ...
Rudy S's user avatar
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42 views

Pricing equation with two correlated states

Consider the following asset pricing setting for a perpetual defaultable coupon bond with price $P(V,c)$, where $V$ is the value of the underlying asset and $c$ is a poisson payment that occurs with ...
Luca Gi's user avatar
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1 answer
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Non-stationarity and repricing as a source of idiosyncratic and systematic "risk"?

1.Assuming a one period economy with two assets in which cash flows are assigned certain probabilities, using the CAPM, we can derive the P0 given the E(CF) at t1. Within this distribution, we have ...
Leonid Konoplev's user avatar
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If investors face different tax rates, how can an asset pricing model be built so that it satisfies the incentive constraints of both investors?

The CAPM and other models have been expanded to include the impact of corporate/personal taxes. However, what if these tax rates differ for an investor pool holding the same equity stake (which by ...
lkonoplev's user avatar
2 votes
1 answer
70 views

Beyond the mean-variance framework, can expected returns be HIGHER for an individual due to a HIGHER risk aversion?

In the mean-variance framework, the only way to get a higher expected return is to be exposed to a higher beta, and the more risk-averse an agent, the lower the beta of their portfolio (lending ...
lkonoplev's user avatar
6 votes
1 answer
250 views

Why can I use equilibrium asset pricing models to predict future returns?

This is a general question that applies to the CAPM and any version of the APT (e.g. the Fama & French three factor model). Speaking in terms of the APT: Assuming a simple one-index version of the ...
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In traditional asset pricing and valuation, why does the cost of equity increase with the AMOUNT of leverage but not with DEFAULT RISK? [closed]

When a firm's default risk increases, the cost of debt obviously rises, which increases the WACC and decreases firm value. However, what happens to the cost of equity in this case? Has the proportion ...
lkonoplev's user avatar
1 vote
0 answers
23 views

Financial constraints, stock return and R&D [closed]

I am doing research on "Financial constraints, stock return and R&D in India". we have constructed the Financial constraints index with the help of Kaplan and Zingles (1997) and Lamont ...
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1 answer
104 views

Difference between Trader Behavior and Analysis/Inference

In the academic literature - often "momentum" and "positive feedback" traders are used interchangeably. Like "Most researchers have found that institutional investors are ...
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Testing predictability of a proposed predictor in case of multiple returns

Say I have a T daily observations for the last ten years on a new predictor $x_t$ which I think is a predictor of the expected weekly return on the stock market, $r_{t,t+5} = r_{t+1}+...+r_{t+5}$, ...
wlsdnwlsntus's user avatar
1 vote
2 answers
62 views

Is there a difference between heterogeneous expectations and heterogeneous cost of capital? How are assets priced in these situations?

How are asset prices set when investors face heterogeneous expectations? Does some form of "negotiation" take place so that the market price is set? Can investors face heterogeneous costs ...
lkonoplev's user avatar
1 vote
1 answer
41 views

Incorporating idiosyncratic risk as a pricing factor with GMM

Suppose we are given a dataset with $T$ time periods and $N$ assets or portfolios. We are interested in estimating and testing an augmented CAPM or a multifactor model with an additional factor: the ...
Richard Hardy's user avatar
2 votes
1 answer
101 views

Testing the CAPM: does GRS account for errors in variables (measurement error)?

Suppose we are interested in testing the CAPM using the GRS test. Consider $N$ assets observed for $T$ time periods. Using the notation of Cochrane "Asset Pricing" (2005), the GRS test ...
Richard Hardy's user avatar
2 votes
2 answers
147 views

GMM estimation of the CAPM: why not include sample mean of the market excess return as a moment?

I am trying to wrap my head around GMM estimation of a single factor model such as the CAPM. I started by asking How come the cross-sectional CAPM equation produces $N$ moment conditions (not $1$)? ...
Richard Hardy's user avatar
2 votes
1 answer
66 views

How come the cross-sectional CAPM equation produces $N$ moment conditions (not $1$)?

Reading Cochrane "Asset Pricing" (2005) section 12.2 (p. 241), I got lost in the derivation of the GMM estimator for the single-factor model. Equation $(12.23)$ says the moments are $$ g_T(b)...
Richard Hardy's user avatar
6 votes
0 answers
128 views

Clustered vs. GMM-based standard errors: which ones to use in asset pricing?

Consider estimating an asset pricing model such as the CAPM or a multifactor model using monthly data. Petersen (2009) section "Asset pricing application" suggests use of standard errors ...
Richard Hardy's user avatar
1 vote
2 answers
111 views

Imposing diagonality of error covariance matrix when the CAPM holds

Assuming that the CAPM holds, the total risk of an asset can be partitioned into systematic risk (associated with the market factor) and idiosyncratic risk. Idiosyncratic risk is asset specific. Does ...
Richard Hardy's user avatar
2 votes
1 answer
134 views

Why estimate the (known) market return in the cross-sectional regression of Fama-MacBeth?

Suppose we are given a dataset with $T$ time periods and $N$ assets or portfolios. We are interested in estimating and testing the CAPM. Using Fama-MacBeth style analysis, we first estimate $N$ time ...
Richard Hardy's user avatar
4 votes
1 answer
228 views

Incorporating idiosyncratic risk as a pricing factor Fama-MacBeth style

Suppose we are given a dataset with $T$ time periods and $N$ assets or portfolios. We are interested in estimating and testing the CAPM or a multifactor model. Take the CAPM: $$ r^*_{i,t}=\alpha_i+\...
Richard Hardy's user avatar
0 votes
1 answer
136 views

Does Black-Scholes imply that the expected return for an asset is fixed as the volatility increases? [closed]

I'm new to this, and just trying to understand what options prices imply about asset growth. I'm looking at the following expression for the underlying asset price in the Black-Scholes model, in ...
fairidox's user avatar
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1 answer
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Forward pricing of cashflows with QuantLib - Python

I am building a tool with Quantlib (Python) to work on the forward pricing of different types of assets (inflation linked, amortizing, vanilla, zero coupon bonds). For a number of reasons I am using ...
peanut_butter_from_the_tub's user avatar
1 vote
1 answer
114 views

How do asset prices behave in a single-period and multi-period model?

When we talk about the single-period CAPM, the return in a particular period t can be defined as $(P_t - P_{t-1})/P_{t-1}$. Investors plan at t-1 and get a payoff at t. After this period, the same ...
lkonoplev's user avatar
1 vote
0 answers
195 views

Methods for Constructing Mimicking Portfolios for Observable Factors

I've created some macroeconomic factors (e.g. analogs of real GDP growth) that I believe have explanatory power for asset returns. By a factor here, I mean a stationary time-series of real numbers. I'...
rubikscube09's user avatar
2 votes
1 answer
175 views

How do I interpret my Fama-French and Carhart factor coefficients?

I am required to prepare a portfolio containing 10 companies and analyse their returns over 10 years utilising the Fama-French 3 factor and Carhart 4 factor models. I chose the largest market cap ...
YasG's user avatar
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1 vote
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137 views

intercepts in spanning regression

what does a negative and a positive intercept imply in spanning regression or factor redundancy test? For example, value factor is regressed on the mkt, smb, rmw, and cma and the intercept is negative ...
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