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Asset Pricing Under Prior-Induced Beta Uncertainty

60 Pages Posted: 23 Nov 2016 Last revised: 4 Jul 2017

Shuting (Sophia) Hu

Texas A&M University - Department of Finance

Shane A. Johnson

Texas A&M University - Department of Finance

Yan Liu

Texas A&M University, Department of Finance

Date Written: July 1, 2017

Abstract

We show theoretically that when Bayesian investors face time-series uncertainty about assets' risk exposures, differences in their priors affect the pricing of risk in the cross-section: different priors for the same asset can generate differences in perceived risk exposures, and thereby differences in required returns. The main testable implication is that the relation between required return and risk factor betas is steeper under a low-beta prior than under a high-beta prior. Using novel proxies for investors' priors about assets' exposures to risk factors, we find strong empirical support for our main prediction. Our results have important implications for understanding how prior-induced parameter uncertainty affects asset returns.

Keywords: Parameter uncertainty, Risk factors, 10-K, Item 1a, Currency risk, Commodity risk, Interest rate risk, Recession risk, Bayesian

JEL Classification: D80, D83, G10, G12, G14, G30, M41

Suggested Citation

Hu, Shuting (Sophia) and Johnson, Shane A. and Liu, Yan, Asset Pricing Under Prior-Induced Beta Uncertainty (July 1, 2017). Available at SSRN: https://ssrn.com/abstract=2874056 or http://dx.doi.org/10.2139/ssrn.2874056

Shuting Hu

Texas A&M University - Department of Finance ( email )

357 Wehner
College Station, TX 77843-4218
United States

Shane Johnson

Texas A&M University - Department of Finance ( email )

Mays School of Business
College Station, TX 77843-4218
United States
979-862-3318 (Phone)

Yan Liu (Contact Author)

Texas A&M University, Department of Finance ( email )

Wehner 401Q, MS 4353
College Station, TX 77843-4218
United States

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