A Cross-sectional Theory of Price of Risk (and Risk) Proxies
17 Pages Posted: 8 Apr 2019 Last revised: 8 May 2019
Date Written: May 6, 2019
This paper theoretically reconciliates the several types of value premiums observed in cross-section with the use of aggregate scaled-price ratios - including "value spreads" - as price of risk proxies in time series. Prices in scaled-price ratios reflect risk premiums (and the price of risk), while the scaling variables control for expected cash flows. They differ from risk proxies (without a price component) that only predict returns in cross-section. The ratios between each proxy's risk premium in cross section and the proxy's standard deviation in time series rank the proxies based on their theoretical correlations with the price of risk.
Keywords: Value premium, value spread, dividend-price, price of risk proxies, ranking.
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation