What Does the Cross-Section Tell About Itself? Explaining Equity Risk Premia with Stock Return Moments
79 Pages Posted: 1 Mar 2007 Last revised: 22 Dec 2019
Date Written: December 20, 2019
We derive a parsimonious three-factor asset pricing model (cross-sectional CAPM, CS-CAPM) in which stock return dispersion (realized cross-sectional variance of long-short equity portfolios) and stock return skewness (realized cross-sectional skewness of equity portfolios) are the driving forces in pricing cross-sectional equity risk premia. Market segmentation leads these two factors to be priced in equilibrium. The model offers a large fit for the joint cross-sectional risk premia associated with 16 prominent CAPM anomalies, with explanatory ratios above 40%. The CS-CAPM compares favorably with multifactor models widely used in the literature. The cross-sectional factors are not subsumed by traditional macro risk factors.
Keywords: asset pricing, stock market anomalies, linear multifactor models, CAPM, cross-section of stock returns, realized return variance, realized return skewness, cross-sectional return moments, ICAPM
JEL Classification: G10, G11, G12
Suggested Citation: Suggested Citation