What Does the Cross-Section Tell About Itself? Explaining Equity Risk Premia with Stock Return Moments
Journal of Money, Credit and Banking (forthcoming)
67 Pages Posted: 1 Mar 2007 Last revised: 16 Feb 2021
Date Written: February 16, 2021
We derive a parsimonious equilibrium three-factor asset pricing model (cross-sectional CAPM, CS-CAPM) in which the realized cross-sectional second and third moments of long-short equity portfolio returns are the driving forces in terms of pricing cross-sectional equity risk premia. Stock market segmentation implies that these two (non-market) factors are priced in equilibrium. The three-factor model offers a large fit for the joint cross-sectional risk premia associated with 26 prominent CAPM anomalies, with explanatory ratios around or above 40%. The CS-CAPM compares favorably with multifactor models widely used in the asset pricing literature. The cross-sectional factors are not subsumed by traditional ICAPM 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