Contingent Claim-Based Expected Stock Returns
AFA 2014 Philadelphia, US
EFA 2013 Cambridge, UK;
62 Pages Posted: 11 Mar 2012 Last revised: 19 Oct 2021
Date Written: March 13, 2013
Abstract
We develop and test a parsimonious contingent claims model for cross-sectional returns of stock portfolios formed on market leverage, book-to-market equity, asset growth rate, and equity size. Since stocks are residual claims on firms' assets that generate operating cash flows, stock returns are cash flow rates scaled by the sensitivities of stocks to cash flows. Our model performs well because the stock-cash flow sensitivities contain economic information. Value stocks, high-leverage stocks and low-asset-growth stocks are more sensitive to cash flows than growth stocks, low-leverage stocks and high-asset-growth stocks, particularly in recessions when default probabilities are high.
Keywords: asset pricing anomalies, stock returns, continuous time contingent claim model, structural estimation, GMM, default probability
JEL Classification: G12, G13
Suggested Citation: Suggested Citation
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