Short-Term Interest Rates and Stock Market Anomalies
Paulo F. Maio
Hanken School of Economics
New University of Lisbon - Nova School of Business and Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)
July 23, 2016
We present a simple two-factor model that helps explaining several CAPM anomalies -- value premium, return reversal, equity duration, asset growth, and inventory growth. The model is consistent with Merton's ICAPM framework and the key risk factor is the innovation on a short-term interest rate -- the Fed funds rate or the T-bill rate. This model explains a large fraction of the dispersion in average returns of the joint market anomalies. Moreover, the model compares favorably with alternative multifactor models widely used in the literature. Hence, short-term interest rates seem to be relevant for explaining several dimensions of cross-sectional equity risk premia.
Number of Pages in PDF File: 76
Keywords: cross-section of stock returns; asset pricing; intertemporal CAPM; state variables; linear multifactor models; predictability of returns; value premium; long-term reversal in returns; equity duration anomaly; corporate investment anomaly; inventory growth anomaly
JEL Classification: E44, G12, G14
Date posted: January 17, 2012 ; Last revised: July 25, 2016
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