Working Paper: CEPR ID: DP13974
Authors: Laurent Calvet; Sebastien Betermier; Evan Jo
Abstract: This paper presents a frictionless neoclassical model of financial markets in which firm sizes, stock returns, and the pricing kernel are all endogenously determined. The model parsimoniously specifies the supply and demand of financial capital allocated to each firm and provides general equilibrium sizes and returns in closed form. We show that the interaction of supply and demand can coherently explain a large number of asset pricing facts. The equilibrium security market line is flatter than the CAPM predicts and can be nonlinear or downward-sloping. The model also generates the size, profitability, investment growth, value, asymmetric volatility, betting-against-beta, and betting-against-correlation anomalies, while also fitting the cross-section of firm characteristics.
Keywords: asset pricing anomalies; capital allocation; general equilibrium; factor-based investing; production economy
JEL Codes: G11; G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| firm characteristics (L20) | stock returns (G12) |
| profitability (L21) | firm size (L25) |
| profitability (L21) | risk pricing (G13) |
| state risk exposure (G52) | stock returns (G12) |
| state risk exposure (G52) | correlation with market returns (G17) |
| correlation with market returns (G17) | positive alphas (C46) |
| state risk (H70) | flattening of SML (G19) |
| firm characteristics + state risks (G32) | expected returns (G17) |