High Expected-Volatility Thresholds, Factor Premia, and Intermediary Asset Pricing
90 Pages Posted: 30 Sep 2016 Last revised: 1 Dec 2018
Date Written: November 23, 2018
Over 1960 to 2017, we show that the premia from holding high-beta stocks (versus low-beta stocks) and small-cap stocks (versus large-cap stocks) are earned solely following times when the expected stock-market volatility breaches an approximate top-quintile threshold. Such time-variation in risk premia fits with the nonlinear risk-return relation suggested by the IAP literature. Further, fitting with IAP implications, we find that high-beta stocks and small-cap stocks (relative to low-beta and large-cap stocks): (1) earn even a higher premia following periods that meet both top-quintile expected-volatility and bottom-quintile intermediary-capital-ratio thresholds; (2) earn a higher premia following a top-quintile expected-volatility threshold even in non-recessionary times; (3) have a stronger negative sensitivity to illiquidity shocks; and (4) have greater fundamental-valuation ambiguity. Conversely, for the Fama-French HML, RMW, and CMA factors, none of these patterns are comparably evident. In sum, our study provides compelling evidence that IAP influences have an important role in understanding beta- and size-based risk premia, but not HML, RMW, and CMA risk premia.
Keywords: Factor risk premia, intermediary asset pricing, illiquidity risk, intertemporal risk-return tradeoff
JEL Classification: G11, G12
Suggested Citation: Suggested Citation