It will turn out that the most important characteristic is the risk of an asset. Cochrane 1996 nds that a simple production based asset pricing model that relates asset returns to returns on aggregate investment performs as well as the capm and the chen, ross and roll factor model and outperforms the simple consumption based model. Recently, with the advance of a longrun risk theory in the eld of 1. Production based asset pricing term structure abstract this paper considers the term structure of interest rates implied by a production based asset pricing model in which the fundamental drivers are investment in equipment and structures as well as inflation. Asset pricing with concentrated ownership of capital and. Section 2 presents the productionbased asset pricing model. Although the exact specification of the marginal rate of transformation in proposition 1 is new, its specification is closely related to other popular empirical macrofactor asset pricing models such as cochrane 1996 and li et. At the same time, oil inventories increase and oil consumption falls. Chapter 9 the capital asset pricing model flashcards. Productionbased measures of risk for asset pricing 2010. Journal of risk and financial management article between p and q.
Criticism of capm and beta versus other risk measures. A stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation inferred from producers firstorder conditions. Although the risk measure of beta in the capital asset pricing model seems to survive this major deciency, it su. While our paper fits within the third asset pricing approach, it is fundamentally different from the other productionbased asset pricing papers. The slope of this line, j, or simply beta, is perhaps the most commonly used measure of equity risk. Pogue1 today, most students of financial management would agree that the treatment of risk is the main element in financial decision making. Risk aversion, the labor margin, and asset pricing in dsge. In some cases, ranking targets or thresholds may be established. Risk attribution and portfolio performance measurementan. Production based measures of risk for asset pricing, journal of monetary economics, elsevier, vol. Production based asset pricing framework some numbers figure.
Productionbased measures of risk for asset pricing by. T1 productionbased measures of risk for asset pricing. This chapter explores these criticisms, alternative measures of risk, and the other methods used to estimate the cost of equity capital. This logic led him to develop the implications of a production based asset pricing model in which covariances of asset returns with macroeconomic measures of investment are important risk factors. The consumptionbased asset pricing model is introduced in section 2. Asset pricing implications bernard herskovicy job market paper z january 22, 2015 abstract this paper studies asset pricing in a multisector model in which sectors are connected to each other through an inputoutput network. I develop a novel procedure to measure the marginal rates of transformation in practice from industry output and price data. Finally, the empirical failure of the capm and the theoretical appeal of multifactor models led fama and french 1992, 1993, 1995, 1996 to develop a. The power law exponents for assets, in their view, provide investors with more realistic risk measures for these assets.
N2 a stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation inferred from producers firstorder conditions. Our paper shows that including such taxes can have a signicant impact on both the real economy and asset prices. Citeseerx document details isaac councill, lee giles, pradeep teregowda. An overview of asset pricing models university of bath bath.
The last step in the development of the sharpelintner model is to use the. An exception is veronesi 2000, who examines the effect of information quality on the equity premium in a lucas asset pricing model that also features an intangible but unambiguous signal. Productionbased measures of risk for asset pricing. Asset pricing implications of firms financing constraints. Evaluating asset pricing implications of dsge models. Productionbased measures of risk for asset pricing by frederico. June 24 2017 frederico belo us bancorp professor in. A stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation. Mar 29, 2020 production based measures of risk for asset pricing, 2010, journal of monetary economics, 572, 146163. In the context of the capital asset pricing model capm the relevant risk is a. Frederico belo, production based measures of risk for asset pricing, journal of monetary economics, 57, 2, 146, 2010. The marginal rate of transformation implies a novel macrofactor asset pricing model that does a reasonable job explaining the crosssectional variation in average stock returns with plausible parameter values. Productionbased measures of risk for asset pricing, 2010, journal of monetary economics, 572, 146163. Return on the risk free asset the return that an investor receives on a safe asset that is free from credit risk what do investors usually use as the risk free rate.
Pdf supplementary material for productionbased measures. Pdf introduction to asset pricing and portfolio performance. A pure productionbased asset pricing model wharton finance. Figures xiiitables xvpreface xviipart i static portfolio choice and asset pricing1 choice under uncertainty 31. An introduction to risk and return concepts and evidence by franco modigliani and gerald a. The capm measures an asset risk as the covariance of its return with the market portfolio return. These models are born out of modern portfolio theory, with the capital asset pricing. Bibliography includes bibliographical references and index. We conclude that the liquidity risk indeed appears to be priced. The marginal rate of transformation implies a novel macrofactor asset pricing model that does a reasonable. A growing literature in macroeconomics also highlights the e. Evaluating the specification errors of asset pricing models. Theory and applications is a part of the princeton series in finance.
An overview asset liability management alm can be defined as a mechanism to address the. Productionbased measures of risk for asset pricing sciencedirect. Using a simple consumptionbased asset pricing model that explains nearly twothirds of the variation in average. We therefore provide one of the first quantitative frameworks to assess the magnitudes of both the loss of investor welfare and the reduction in market value due to imperfect investor protection. A stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation of output across states of nature, inferred from the producers first order conditions. A model of timevarying risk premia with habits and production. Article pdf available in journal of monetary economics 66 may 2012 with 295 reads how we measure reads. Gomes university of pennsylvania and cepr amir yaron university of pennsylvania and nber lu zhang university of rochester and nber we use a productionbased asset pricing model to investigate whether financing constraints are quantitatively important for the crosssection. Measuring risk and risk aversion june 20, 2006 asset pricing. Evaluating alternative methods of asset pricing based on the overall magnitude of pricing errors, finance research letters, elsevier, vol. Those papers do not consider any type of capital income taxes.
Higher j implies greater covariance with market return. Productionbased measures of risk for asset pricing frederico beloy december 21, 2009 abstract a stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation inferred from producers rstorder conditions. Disaster risk and its implications for asset pricing. Productionbased asset pricing and the link between stock. Productionbased measures of risk for asset pricing by frederico belo, bob goldstein, joao gomes, francois gourio, luigi guiso, lars hansen, boyan jovanovic, christian julliard, xiaoji lin, stavros panageas, andrew patton, ioanid rosu, nikolai roussanov, nick souleles, ana vitorino, zhenyu wang, amir yaron, motohiro yogo and jianfeng yu. Productionbased measures of risk for asset pricing article in journal of monetary economics 572. Topics in asset pricing hebrew university of jerusalem. The market has a beta of 1, and it can be used to gauge the risk of a security. Under general equilibrium theory prices are determined through market pricing by supply and demand. The marginal rate of transformation implies a novel macrofactor asset pricing model that does a reasonable job explaining the crosssectional variation in average stock returns with plausible. Production based asset pricing and the link between stock returns and economic fluctuations john h. November 30, 2015 abstract we propose a novel approach to measuring rmlevel risk exposures and costs of equity. A risk asset is any asset that carries a degree of risk.
Supplementary material for productionbased measures of. Cochrane abstract this paper describes a production based asset pricing model. Firm characteristics, consumption risk, and firmlevel risk exposures robert f. This proposition shows that a macrofactor asset pricing model follows from a production based asset pricing setup. Even by using the arrowpratt measure of risk aversion, the utility function has to be known to. Blackscholes option pricing is the classic example of this approach. The intercept, j, is known as treynors alpha and represents the sustained economic pro. An overview of asset pricing models andreas krause university of bath school of management phone. I am very grateful to the members of my dissertation committee, john cochrane chair, john heaton, monika piazzesi, and pietro veronesi for many helpful discussions. Review the historical record and the concept of the equity market risk premium. Implications for the crosssection of returns, journal of finance, american finance association, vol.
The examination of the intertemporal distribution of us productivity risk suggests that the conditional mean of productivity growth is an important determinant of macro quantities and asset prices. Differences exist, however, between different models in how to measure this market risk. This work ts into the line of production based models of asset pricing, that have until recently struggled to account for unconditional moments of asset prices without sacri cing too much of a t of macroeconomic variables. In relative pricing we infer an asset s value given the prices of some other asset. The reliability of capital asset pricing model on valuation. It is analogous to the standard consumption based model, but it uses producers and production functions in the place of consumers and utility functions. Among the many issues raised by recent work in asset pricing, two appear to be. Tuzel 2010 finds that firms real estate holdings are positively related to their future equity returns because slower depreciation of structures makes real estate harder to adjust, and increases firms exposure to aggregate shocks. The book gives some practical advice on how a small and mediumsized bank can start to develop its own al risk management system by focusing on the interest rate risk and liquidity risk management policy and the measurement of these risks. Treasury bills because there is an underlying assumption that the u.
Hou, xue, and zhang 2015 measure investmenttocapital, ia, as the annual. Firm characteristics, consumption risk, and firmlevel risk. Zin preferences to generate movements in risk aversion. This way of writing the pricing relation is called risk neutral valuation because it has the same form as the value of a risky asset in a market where investors are risk neutral. Frederico, production based measures of risk for asset pricing september 3, 2010. The model matches the average yield curve up to fiveyear maturity almost perfectly. The framework for the analysis is a real business cycle model with two types of agents. In the asset pricing model of bansal and yaron 2004, an increase in aggregate volatility lowers asset prices and, importantly, shocks to volatility carry a separate risk premium. While the capital asset pricing model capm explains how investors should act and price risk, empirical research has shown that investors often act differently than predicted by capm. Lecture notes on advanced corporate financial risk management john e. Asset pricing with liquidity risk faculty and research. Topics in asset pricing in the absence of undervalued investments, longonly positons cannot generate performance. Mariano massimiliano croce abstract this study examines the intertemporal distribution of productivity risk. Beta measures the amount of systematic risk an individual security or an industrial sector has relative to the whole stock market.
Changes in the structure of the network are sources of systematic risk re ected in equilibrium. Tail risk consumption based asset pricing models the discount factor representation of asset pricing models the equity premium puzzle the risk free rate puzzle the epsteinzin preferences long run risk habit formation prospect theory 3 professor doron avramov. The marginal rate of transformation implies a novel macrofactor asset pricing model. Beta coefficient has been the classic measure of risk in equilibrium based asset pricing models. Risk asset generally refers to assets that have a significant degree of price volatility, such as equities, commodities, highyield bonds, real estate, and currencies. Using a flexible representation of firms production technology, producers. A model of timevarying risk premia with habits and production ian dewbecker duke university february 20, 2014 abstract this paper builds on the productionbased asset pricing literature to generate return predictability in general equilibrium. The pq measure for pricing in a sset liability management marcel t. Oosterlee 2,3 1 ortec finance, 3011 xb rotterdam, the netherlands.
We introduce two new features into a standard production based equilibrium. Rather than using some inflation measure we subtract a benchmark asset. Productionbased asset pricing, production under uncertainty. Focusing on postwar us data, i show that the conditional mean of productivity growth is timevarying and extremely persistent. Thus, im is the covariance risk of asset i in m measured relative to the average covariance risk of assets, which is just the variance of the market return. Indeed, avramov, cheng, and hameed 2016 show that even the top decile of actively managed.
Optimal investment, growth options, and security returns. It is therefore surprising that so little attention has been paid to computing this coe. The marginal rate of transformation implies a novel macrofactor asset pricing model that does a reasonable job explaining the crosssectional variation in average stock returns with. It derives a pricing kernel based on the 2 see liew and vassalou 2000 and vassalou 2003 for recent applications of this approach to crosssectional asset pricing. At one end, the capital asset pricing model measures the market risk with a beta measured relative to a market portfolio, and at the other are multifactor models that measure market risk using multiple betas estimated relative to different factors. These models endogenize consumption and cash ows and o er a deeper understanding of the links between stock prices and the real economy. Pdf productionbased measures of risk for asset pricing. Rf, is described by the sensitivities of its returns to the market. In either case, though, the bank has to measure the risk exposure and formulate strategies to minimise or mitigate risk. Oil volatility risk lin gao, ste en hitzemann, ivan shaliastovich, and lai xu july 2018 abstract an increase in oil price volatility predicts a decline in economic growth, controlling for market volatility and business cycle variables. Here asset prices jointly satisfy the requirement that the quantities of each asset supplied and the quantities demanded must be equal at that price so called market clearing.
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