Factor-Loading Uncertainty and Expected Returns

52 Pages Posted: 12 Nov 2008 Last revised: 13 Sep 2012

Chris Armstrong

University of Pennsylvania - Accounting Department

Snehal Banerjee

University of California, San Diego (UCSD) - Rady School of Management

Carlos Corona

Carnegie Mellon University

Date Written: August 9, 2012

Abstract

Firm-specific information can affect expected returns if it affects investor uncertainty about risk-factor loadings. We show that a stock's expected return is decreasing in factor-loading uncertainty, controlling for the average level of its factor loading. When loadings are persistent, learning by investors can induce time-series variation in price-dividend ratios, expected returns, and idiosyncratic volatility, even when the aggregate risk-premium is constant and fundamental shocks are homoscedastic. Consistent with our predictions, we estimate that average annual returns of a firm with the median level of factor-loading uncertainty are 400 to 525 basis points lower than a comparable firm without factor-loading uncertainty.

Keywords: Expected Return, Information Quality, Uncertainty, Stochastic volatility

JEL Classification: G12, G14

Suggested Citation

Armstrong, Chris and Banerjee, Snehal and Corona, Carlos, Factor-Loading Uncertainty and Expected Returns (August 9, 2012). McCombs Research Paper Series No. ACC-03-08; AFA 2010 Atlanta Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1300100 or http://dx.doi.org/10.2139/ssrn.1300100

Chris S. Armstrong

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Snehal Banerjee (Contact Author)

University of California, San Diego (UCSD) - Rady School of Management ( email )

9500 Gilman Drive
Rady School of Management
La Jolla, CA 92093
United States

Carlos Corona

Carnegie Mellon University ( email )

5000 Forbes Avenue
Pittsburgh, PA 15213-3890
United States

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