Covariances versus Characteristics in General Equilibrium / Xiaoji Lin, Lu Zhang.

Format:

Book

Author/Creator:

Lin, Xiaoji.

Contributor:

National Bureau of Economic Research.

Zhang, Lu.

Series:

Working Paper Series (National Bureau of Economic Research) no. w17285.

NBER working paper series no. w17285

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2011.

Summary:

We question a deep-ingrained doctrine in asset pricing: If an empirical characteristic-return relation is consistent with investor "rationality," the relation must be "explained" by a risk factor model. The investment approach changes the big picture of asset pricing. Factors formed on characteristics are not necessarily risk factors: Characteristics-based factor models are linear approximations of firm-level investment returns. The evidence that characteristics dominate covariances in horse races does not necessarily mean mispricing: Measurement errors in covariances are more likely to blame. Most important, the investment approach completes the consumption approach in general equilibrium, especially for cross-sectional asset pricing.

Notes:

Print version record

August 2011.