Working Paper: NBER ID: w11816
Authors: Tano Santos; Pietro Veronesi
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.
Keywords: cash flow risk; discount risk; value premium; CAPM; Fama-French
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| higher cash flow risk (G32) | classification as a value stock (G12) |
| size of the value premium (D46) | larger during bad economic times (N12) |
| cash flow risk and risk preferences (G40) | observed value premium (G19) |
| cash flow characteristics (G32) | stock returns (G12) |