Microfounding the Fama-MacBeth Regression

59 Pages Posted: 13 Aug 2019 Last revised: 10 May 2021

See all articles by Pablo Castaneda

Pablo Castaneda

Universidad Adolfo Ibanez

Jorge Sabat

Universidad Diego Portales

Date Written: August 2, 2019

Abstract

In a new methodological approach to empirically test which factors determine equilibrium asset prices, Berk and Van Binsbergen (2016) find that the Capital Asset Pricing Model would better explain how capital flows into and out of mutual funds. This result is puzzling given that empirical asset pricing tests based on cross-sectional returns favor multifactor models `a la Fama and French (1993). In this paper, we focus on mutual funds managers’ investment decisions instead of mutual funds investors’ decisions. Using a structural model, we recover the factor risk premiums from observed fund managers’ investment decisions, for a set of well published asset pricing models. We find that Fama and French (1993) expanded by the momentum factor of Carhart (1997), and the liquidity factor of Pástor and Stambaugh (2003), can explain the largest fraction of funds’ investment decisions. Most notably, we also find that the macro-finance model a la Chen et al. (1986) is the one that best explains the observed mean-variance efficiency of the market portfolio. We reconcile this apparent paradox, by showing that factors that influence mutual fund managers’ asset allocation decisions (eg. value-size investing) may not survive at the aggregate level.

Keywords: Factor Models, Rational, Behavioral, Asset Pricing

JEL Classification: C18, G11, G12, G14

Suggested Citation

Castaneda, Pablo and Sabat, Jorge, Microfounding the Fama-MacBeth Regression (August 2, 2019). Available at SSRN: https://ssrn.com/abstract=3435141 or http://dx.doi.org/10.2139/ssrn.3435141

Pablo Castaneda

Universidad Adolfo Ibanez ( email )

Av Diagonal Las Torres 2700
Office 516C
Penalolen, Penalolen 7941169
Chile
(+56 2) 331 1193 (Phone)
(+56 2) 331 1904 (Fax)

HOME PAGE: http://www.uai.cl/docentes/pablo-castaneda-navarrete

Jorge Sabat (Contact Author)

Universidad Diego Portales ( email )

Av. Santa Clara 797
Santiago, Región Metropolitana
Chile

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

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