Equity Premia and State-Dependent Risks

44 Pages Posted: 25 Sep 2011

See all articles by Michel Normandin

Michel Normandin

HEC Montreal - Institute of Applied Economics

Mohammed Bouaddi

The American University in Cairo

Denis Larocque

HEC Montreal - Department of Management Sciences

Multiple version iconThere are 2 versions of this paper

Date Written: July 24, 2011

Abstract

For the first time in the literature, this paper extends the CCAPM to establish the empirical relations between equity premia and state-dependent consumption and market risks. These relations are derived from a flexible, yet tractable, mixture distribution admitting the existence of two regimes, rather than the usual normal distribution. Focusing on the market return, we find that the consumption and market risks are priced in each state, and the responses of expected equity premia to these risks are state dependent. Extending to various portfolio returns, we show that the responses to downside consumption risks are the most important, are almost always statistically larger than the responses to upside consumption risks, and are much larger for firms having smaller sizes and facing more financial distresses.

Keywords: Consumption-based Capital Asset Pricing Model, Downside and upside consumption and market risks, Mixture of truncated normal distributions

JEL Classification: C16, G12

Suggested Citation

Normandin, Michel and Bouaddi, Mohammed and Larocque, Denis, Equity Premia and State-Dependent Risks (July 24, 2011). Midwest Finance Association 2012 Annual Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1933209 or http://dx.doi.org/10.2139/ssrn.1933209

Michel Normandin (Contact Author)

HEC Montreal - Institute of Applied Economics ( email )

3000, ch. de la Côte-Ste-Catherine
Montréal, Quebec H3T 2A7
Canada

Mohammed Bouaddi

The American University in Cairo ( email )

P.O. Box 2511
Cairo
Egypt

Denis Larocque

HEC Montreal - Department of Management Sciences ( email )

Montreal, Quebec H3T 2A7
Canada

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