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

See all articles by Ilan Cooper

Ilan Cooper

BI Norwegian Business School

Liang Ma

University of South Carolina - Darla Moore School of Business

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics

Date Written: December 20, 2019

Abstract

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

Cooper, Ilan and Ma, Liang and Maio, Paulo F., What Does the Cross-Section Tell About Itself? Explaining Equity Risk Premia with Stock Return Moments (December 20, 2019). Available at SSRN: https://ssrn.com/abstract=966500 or http://dx.doi.org/10.2139/ssrn.966500

Ilan Cooper

BI Norwegian Business School ( email )

Nydalsveien 37
Oslo, 0442
Norway

Liang Ma

University of South Carolina - Darla Moore School of Business ( email )

1014 Greene Street
Columbia, SC 29208
United States
803-777-6366 (Phone)

HOME PAGE: http://sites.google.com/site/liangmaweb/

Paulo F. Maio (Contact Author)

Hanken School of Economics - Department of Finance and Statistics ( email )

FI-00101 Helsinki
Finland

HOME PAGE: http://sites.google.com/site/paulofmaio/home

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