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Asset Pricing: Cross-section of Returns and Investors

Paper Session

Sunday, Jan. 5, 2020 1:00 PM - 3:00 PM (PDT)

Manchester Grand Hyatt, Seaport A
Hosted By: American Finance Association
  • Chair: Annette Vissing-Jorgensen, University of California-Berkeley

Which Investors Matter for Equity Valuations and Expected Returns?

Ralph Koijen
,
University of Chicago
Robert Richmond
,
New York University
Motohiro Yogo
,
Princeton University

Abstract

To understand why valuation ratios vary across firms and over time, a large litera ture in asset pricing decomposes these ratios into expected returns and expected growth rates of firm fundamentals. This literature leaves two fundamental questions unanswered: (i) what information do investors attend to in forming their demand beyond prices and (ii) how important are different investors in the price formation process? We use a demand system approach to answer both questions. We first show that a small set of characteristics explains the majority of variation in a panel of firm-level valuation ratios across countries. We then estimate an asset demand system using investor-level holdings data, allowing for flexible substitution patterns within and across countries. We use this framework to measure the relative importance of investors — differentiated by type, size, and active share — for connecting firm characteristics to prices and long-horizon expected returns.

The Low-Minus-High Portfolio and the Factor Zoo

Daniel Andrei
,
McGill University
Julien Cujean
,
University of Bern
Mathieu Fournier
,
HEC Montreal

Abstract

Regardless of whether the CAPM is rejected for valid reasons or by mistake, a single long-short portfolio will always explain, together with the market, 100% of the cross- sectional variation in returns. Yet, this portfolio, which we coin the “Low-Minus-High (LMH) portfolio,” need not proxy for fundamental risk. We show theoretically how factors based on valuation ratios (e.g, book-to-market), or on investment rates, can be proxies for the LMH portfolio. More generally, the empiricist can uncover an infinity of proxies for the LMH portfolio, thus unleashing the factor zoo.

Competition Links and Stock Returns

Assaf Eisdorfer
,
University of Connecticut
Kenneth Froot
,
Harvard Business School
Gideon Ozik
,
EDHEC Business School
Ronnie Sadka
,
Boston College

Abstract

We consider a firm’s competitiveness based on the manner by which other firms mention it on their 10-K filings. Using all public firm filings simultaneously, we implement a PageRank-type algorithm to produce a dynamic measure of firm competitiveness, denoted C-Rank. A high-minus-low C-Rank portfolio yields 16% alpha annually, where return predictability mainly stems from cross-sector competitiveness. The findings are largely consistent with investor underreaction to firm business opportunities identified by other strong firms. Nevertheless, stock return covariation with the C-Rank portfolio spread suggests that part of the return predictability can be interpreted as compensation for systematic cross-sector disruption risk.
Discussant(s)
John Campbell
,
Harvard University
Serhiy Kozak
,
University of Maryland
Christopher Polk
,
London School of Economics
JEL Classifications
  • G1 - General Financial Markets