Covariances, Characteristics, and General Equilibrium: A Critique

41 Pages Posted: 22 Jul 2011 Last revised: 27 Feb 2012

See all articles by Xiaoji Lin

Xiaoji Lin

University of Minnesota

Lu Zhang

Ohio State University - Fisher College of Business; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: December 1, 2011

Abstract

We question a deep-ingrained doctrine in asset pricing: if an empirical characteristic-return relation is consistent with investor “rationality,” the relation must be “explained” by a risk factor model. The investment approach changes the big picture of asset pricing. Factors formed on characteristics are not necessarily risk factors: characteristics-based factor models can be linear approximations of firm-level investment returns. The evidence that characteristics dominate covariances in horse races does not necessarily mean mispricing: measurement errors in covariances are likely to blame. Most important, the investment approach completes the consumption approach in general equilibrium, especially for cross-sectional asset pricing.

Keywords: covariances, characteristics, general equilibrium, asset pricing anomalies, capital markets research in accounting, market efficiency, investment-based asset pricing

JEL Classification: D21, D92, E22, E44, G12, G14, G31, G32, G35

Suggested Citation

Lin, Xiaoji and Zhang, Lu, Covariances, Characteristics, and General Equilibrium: A Critique (December 1, 2011). Fisher College of Business Working Paper No. 2011-03-015, Available at SSRN: https://ssrn.com/abstract=1890886 or http://dx.doi.org/10.2139/ssrn.1890886

Xiaoji Lin

University of Minnesota ( email )

420 Delaware St. SE
Minneapolis, MN 55455
United States

Lu Zhang (Contact Author)

Ohio State University - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
585-267-6250 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
144
Abstract Views
1,779
rank
46,915
PlumX Metrics