Cash-Flow Risk, Discount Risk, and the Value Premium

59 Pages Posted: 19 Feb 2006 Last revised: 8 Mar 2006

See all articles by Tano Santos

Tano Santos

Columbia Business School; National Bureau of Economic Research (NBER)

Pietro Veronesi

University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Date Written: December 2005

Abstract

A habit persistence, general equilibrium model with multiple assets matches both the time series properties of the market portfolio and the cross-sectional predictability of returns on price sorted portfolios, the value premium. Consistent with empirical evidence, the model shows that (a) value stocks are those with higher cash-flow risk; (b) the size of the value premium is larger in %u201Cbad times,%u201D due to time variation in risk preferences; (c) the unconditional CAPM fails, because of general equilibrium restrictions on the market portfolio. The dynamic nature of the value premium rationalizes why the conditional CAPM and a Fama and French (1993) HML factor outperform the unconditional CAPM.

Suggested Citation

Santos, Tano and Veronesi, Pietro, Cash-Flow Risk, Discount Risk, and the Value Premium (December 2005). NBER Working Paper No. w11816, Available at SSRN: https://ssrn.com/abstract=875692

Tano Santos (Contact Author)

Columbia Business School ( email )

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National Bureau of Economic Research (NBER)

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Pietro Veronesi

University of Chicago - Booth School of Business ( email )

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Centre for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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United States

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