Market Expectations in the Cross Section of Present Values
Bryan T. Kelly
University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)
Arizona State University (ASU) - Finance Department
July 1, 2012
Journal of Finance, Forthcoming
Chicago Booth Research Paper No. 11-08
AFA 2013 San Diego Meetings Paper
Fama-Miller Working Paper
Returns and cash flow growth for the aggregate U.S. stock market are highly and robustly predictable. Using a single factor extracted from the cross section of book- to-market ratios, we find an out-of-sample return forecasting R-squared as high as 13% at the annual frequency (0.9% monthly). We document similar out-of-sample predictability for returns on value, size, momentum and industry-sorted portfolios. We present a model linking aggregate market expectations to disaggregated valuation ratios in a dynamic latent factor system. We find that spreads in growth and value portfolios’ exposures to economic shocks are key to identifying predictability and are consistent with duration-based theories of the value premium. Our findings suggest that discount rates are far less persistent, and their shocks far more volatile, than implied by leading asset pricing models.
Number of Pages in PDF File: 52
JEL Classification: G11, G12, G17
Date posted: February 2, 2011 ; Last revised: September 11, 2012
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