Interpreting Risk Premia Across Size, Value, and Industry Portfolios

44 Pages Posted: 24 Jul 2003

See all articles by Ravi Bansal

Ravi Bansal

Duke University and NBER

Robert F. Dittmar

University of Michigan, Stephen M. Ross School of Business

Christian T. Lundblad

University of North Carolina Kenan-Flagler Business School

Date Written: February 2003

Abstract

In this paper, we model cash flow and consumption growth rates as a vector-autoregression (VAR), from which we measure the response of cash flow growth to consumption shocks. As the appropriate cash flow proxy is not unambiguous, nor likely to be measured without error, we consider three alternatives for portfolio cash flows: cash dividends, dividends plus repurchases and corporate earnings. We find that the long-run exposure of cash flows to aggregate consumption risk can justify a significant degree of the observed variation in risk premia across size, book-to-market, and industry sorted portfolios. Also, our economic model highlights the reasons for the failure of the market beta to justify the cross-section of risk premia. Most importantly, our results indicate that measured diferences in the long-run exposures of cash flows to aggregate economic fluctuations as captured by aggregate consumption movements contain very valuable information regarding diferences in risk premia. In all, our results indicate that the size, book-to-market and industry spreads are not puzzling from the perspective of economic models.

Suggested Citation

Bansal, Ravi and Dittmar, Robert F. and Lundblad, Christian T., Interpreting Risk Premia Across Size, Value, and Industry Portfolios (February 2003). EFA 2003 Annual Conference Paper No. 711. Available at SSRN: https://ssrn.com/abstract=423964 or http://dx.doi.org/10.2139/ssrn.423964

Ravi Bansal (Contact Author)

Duke University and NBER ( email )

Box 90120
Durham, NC 27708-0120
United States
919-660-7758 (Phone)
919-660-8038 (Fax)

Robert F. Dittmar

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Christian T. Lundblad

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-8441 (Phone)

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