An Accounting-Based Asset Pricing Model and a Fundamental Factor
80 Pages Posted: 10 Jun 2019
Date Written: May 1, 2019
This paper recasts the consumption asset pricing model in terms of observable accounting outcomes by recognizing accounting principles that connect those outcomes to consumption and the risk to consumption. The model prompts the construction of a pricing factor from observed accounting information that contrasts to existing models where accounting data often enter via data dredging. The factor performs well relative to standard factors in explaining cross-sectional returns. Further, it delivers out-of-sample expected returns that forecast the actual returns that investors receive and the forward betas that investors actually experience. The factor return has little correlation with the market portfolio and exhibits the property of protecting payoffs in bad states when consumption is low. This prompts a two-factor representation that combines the market portfolio and a zero-beta portfolio with a hedge against loss to consumption.
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