Past Market Variance and Asset Prices

Posted: 15 Feb 2011

See all articles by Federico M. Bandi

Federico M. Bandi

Johns Hopkins University - Carey Business School

Benoit Perron

University of Montreal - Department of Economics; Center for Interuniversity Research and Analysis on Organization (CIRANO); University of Montreal - Center for Interuniversity Research in Econometrics

Date Written: February 14, 2011

Abstract

Recent work in asset pricing has focused on market-wide variance as a systematic factor and on firm-specific variance as idiosyncratic risk. We study an alternative channel through which the variability of financial market returns may help our understanding of cross-sectional price formation in financial markets. Invoking the countercyclical nature of market variance, we allow the (stochastic) discounting of future cash-flows to depend on the level of past market variance (pmv). Employing pmv as a conditioning variable in a classical consumption-CAPM framework, we derive economically meaningful conditional factor loadings and conditional risk premia. We show that scaling by pmv may also yield more effective pricing results than scaling by successful, alternative variables (such as the consumption-to-wealth ratio) precisely at frequencies at which their predictive ability for excess market returns should be (in theory) and is (empirically) maximal, i.e., business-cycle frequencies.

Keywords: Asset prices, financial markets

Suggested Citation

Bandi, Federico Maria and Perron, Benoit, Past Market Variance and Asset Prices (February 14, 2011). CIRANO - Scientific Publications No. 2011s-16. Available at SSRN: https://ssrn.com/abstract=1761571 or http://dx.doi.org/10.2139/ssrn.1761571

Federico Maria Bandi

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

Benoit Perron (Contact Author)

University of Montreal - Department of Economics ( email )

C.P. 6128, succursale Centre-Ville
Montreal, Quebec H3C 3J7
Canada
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514-343-5831 (Fax)

Center for Interuniversity Research and Analysis on Organization (CIRANO) ( email )

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University of Montreal - Center for Interuniversity Research in Econometrics ( email )

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Montreal, Quebec H3C 3J7
Canada

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