Factor-Loading Uncertainty and Expected Returns

52 Pages Posted: 12 Nov 2008 Last revised: 13 Sep 2012

See all articles by Chris Armstrong

Chris Armstrong

Stanford Graduate School of Business

Snehal Banerjee

University of California, San Diego (UCSD) - Rady School of Management

Carlos Corona

Ohio State University (OSU) - Department of Accounting & Management Information Systems

Date Written: August 9, 2012

Abstract

Firm-specific information can affect expected returns if it affects investor uncertainty about risk-factor loadings. We show that a stock's expected return is decreasing in factor-loading uncertainty, controlling for the average level of its factor loading. When loadings are persistent, learning by investors can induce time-series variation in price-dividend ratios, expected returns, and idiosyncratic volatility, even when the aggregate risk-premium is constant and fundamental shocks are homoscedastic. Consistent with our predictions, we estimate that average annual returns of a firm with the median level of factor-loading uncertainty are 400 to 525 basis points lower than a comparable firm without factor-loading uncertainty.

Keywords: Expected Return, Information Quality, Uncertainty, Stochastic volatility

JEL Classification: G12, G14

Suggested Citation

Armstrong, Chris S. and Banerjee, Snehal and Corona, Carlos, Factor-Loading Uncertainty and Expected Returns (August 9, 2012). AFA 2010 Atlanta Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1300100 or http://dx.doi.org/10.2139/ssrn.1300100

Chris S. Armstrong

Stanford Graduate School of Business ( email )

655 Knight Way
E316
Stanford, CA 94305-5015
United States

HOME PAGE: http://https://www.gsb.stanford.edu/faculty-research/faculty/christopher-s-armstrong

Snehal Banerjee (Contact Author)

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

Carlos Corona

Ohio State University (OSU) - Department of Accounting & Management Information Systems ( email )

2100 Neil Avenue
Columbus, OH 43210
United States

HOME PAGE: http://https://fisher.osu.edu/people/corona.55

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