The Fed 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)
October 8, 2013
We present a simple three-factor asset pricing model that helps explain several CAPM anomalies -- value premium, long-term reversal in returns, corporate investment, price momentum, and earnings momentum. The two key risk factors in the model are related with the same state variable -- the Fed funds rate. The model explains a large percentage of the dispersion in average returns associated with each anomaly, with cross-sectional R^2 estimates between 46% and 91%. Moreover, the model compares favorably with alternative multifactor models in pricing the joint five CAPM anomalies. Hence, monetary policy actions seem to be relevant for explaining cross-sectional equity risk premia.
Number of Pages in PDF File: 78
Keywords: Cross-section of stock returns; Asset pricing; Intertemporal CAPM; Conditional CAPM; Conditioning information; State variables; Linear multifactor models; Predictability of returns; Fama-French factors; Value premium; Momentum; Long-term reversal in returns; corporate investment anomaly; earnings
JEL Classification: E44, G12, G14working papers series
Date posted: January 17, 2012 ; Last revised: October 9, 2013
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