Factor-Loading Uncertainty and Expected Returns
University of Pennsylvania - Accounting Department
Kellogg School of Management - Department of Finance
Carnegie Mellon University
August 9, 2012
AFA 2010 Atlanta Meetings Paper
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.
Number of Pages in PDF File: 52
Keywords: Expected Return, Information Quality, Uncertainty, Stochastic volatility
JEL Classification: G12, G14
Date posted: November 12, 2008 ; Last revised: September 13, 2012
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