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Tradable Aggregate Risk Factors and the Cross-Section of Stock Returns

41 Pages Posted: 29 Apr 2013 Last revised: 15 Dec 2016

Nikolay Doskov

Norges Bank Investment Management (NBIM)

Tapio Pekkala

Pacific Investment Management Company (PIMCO)

Ruy Ribeiro

Pontifical Catholic University of Rio de Janeiro (PUC-Rio) - Department of Economics

Date Written: December 2016

Abstract

We propose a new set of tradable aggregate risk factors that help us understand the cross-section of stock returns. We argue that the true stochastic discount factor is a combination of aggregate return factors that drive equity market returns. Hence, we consider new factors using data such as market dividend swaps and market volatility futures. In the particular case of value and size portfolios, we find that differences in expected returns can be explained by a single-factor projection of the discount factor that loads only on a dividend growth return factor constructed with market dividend swap data. Hence, value and small capitalization stocks have higher expected returns due to their exposure to dividend growth returns implying that growth risks (dividend growth news and/or expected return news associated with dividend growth) are the only source of their risk premia. A tradable dividend level factor and a volatility-based factor are also priced in the cross-section of other stock portfolios sorted on dividend yield, earnings yield and cash-flow-to-price.

Keywords: Asset Pricing; Factor model; Value premium; Size premium

JEL Classification: G12

Suggested Citation

Doskov, Nikolay and Pekkala, Tapio and Ribeiro, Ruy, Tradable Aggregate Risk Factors and the Cross-Section of Stock Returns (December 2016). Available at SSRN: https://ssrn.com/abstract=2200889 or http://dx.doi.org/10.2139/ssrn.2200889

Nikolay Doskov

Norges Bank Investment Management (NBIM) ( email )

Bankplassen 2
P.O. Box 1179 Sentrum
Oslo, NO-0107
Norway

Tapio Pekkala

Pacific Investment Management Company (PIMCO) ( email )

United States

Ruy Ribeiro (Contact Author)

Pontifical Catholic University of Rio de Janeiro (PUC-Rio) - Department of Economics ( email )

Rua Marques de Sao Vicente, 225/206F
Rio de Janeiro, RJ 22453
Brazil

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