Information Precision, Noise, and the Cross-Section of Stock Returns
42 Pages Posted: 28 Jul 2008
Date Written: July 28, 2008
We derive a cross-sectional asset pricing measure from a noisy multi-asset rational expectations equilibrium model. The measure is based on the time-series covariance of an asset's returns and security prices. Empirically, stocks with a measure one standard deviation above and below the average have returns that dier by 0.36% the following month (4.44% per annum) which is statistically significant at the 1%-level. The findings are concentrated in the smallest three deciles of stocks using NYSE breakpoints. Results remain significant after including variables such as stock market capitalization, book-to-market ratio, and the probability of information-based trading. Our measure can be understood as a proxy for information risk and/or supply uncertainty. The two explanations cannot easily be disentangled.
Keywords: Risk Premia, Cross-Sectional Asset Pricing, REE Models
JEL Classification: D8, G1, G10
Suggested Citation: Suggested Citation