Real Risk or Paper Risk? Mis-Measured Factors, Granular Measurement Errors, and Empirical Asset Pricing Tests

65 Pages Posted: 30 Apr 2019 Last revised: 14 Feb 2020

See all articles by Sung Je Byun

Sung Je Byun

Federal Reserve Banks - Federal Reserve Bank of Dallas

Lawrence Schmidt

MIT Sloan School of Management

Date Written: Febrary 2020

Abstract

We study implications of unpriced "granular measurement errors" -- idiosyncratic shocks to large firms that aren't well-diversified in market indices -- for asset pricing tests and propose alternative tests insensitive to them. We find stronger evidence of an intertemporal relation between the expected return and variance of the market after these corrections. Cross-sectionally, estimated market betas -- especially for small/high beta stocks -- are biased, the size anomaly disappears, and the price of risk for the market portfolio is consistent with theory. The granular residual is volatile and less informative about real activity than our adjusted index, potentially rationalizing lower/zero risk compensation.

Keywords: Risk-Return Trade-Off; Idiosyncratic Risk; Empirical Asset Pricing

JEL Classification: C15, C58, G12, G17

Suggested Citation

Byun, Sung Je and Schmidt, Lawrence, Real Risk or Paper Risk? Mis-Measured Factors, Granular Measurement Errors, and Empirical Asset Pricing Tests (Febrary 2020). Available at SSRN: https://ssrn.com/abstract=3362066 or http://dx.doi.org/10.2139/ssrn.3362066

Sung Je Byun

Federal Reserve Banks - Federal Reserve Bank of Dallas ( email )

2200 North Pearl Street
PO Box 655906
Dallas, TX 75265-5906
United States
214-922-5660 (Phone)

HOME PAGE: http://https://sites.google.com/site/sungjebyun/

Lawrence Schmidt (Contact Author)

MIT Sloan School of Management ( email )

77 Massachusetts Avenue
Cambridge, MA 02139-4307
United States

HOME PAGE: http://https://sites.google.com/site/lawrencedwschmidt/home

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