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)
August 8, 2015
We present a simple two-factor asset pricing model that helps explain several CAPM anomalies--value premium, long-term reversal in returns, equity duration, corporate investment, and inventory growth. The key risk factor is the innovation on a short-term interest rate, either the Fed funds rate or the T-bill rate. The model explains a large percentage of the dispersion in average returns for the joint anomalies, with cross-sectional R^2 estimates of 58% and 67% in the estimation with value- and equal-weighted portfolios, respectively. Moreover, the model compares favorably with alternative multifactor models in pricing the large cross-section of stock returns. In this model, value stocks, past long-term losers, stocks with low duration, and stocks of firms that invest less enjoy higher expected returns because they have higher interest rate risk. Hence, short-term interest rates seem to be relevant for explaining cross-sectional equity risk premia.
Number of Pages in PDF File: 74
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: August 18, 2015
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