Cash-flow risk, discount risk, and the value premium

Author / Creator

Santos, Tano

Available as

Online

Summary

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 pr...

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 "bad times," 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

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