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SESSION III-2 : EMPIRICAL FINANCE (18/12/2008 à 14h00)

Conditional Skewness of Aggregate Market Returns

Auteurs : CHAROENROOK Anchada (Vanderbilt University); DAOUK Hazem (Cornell University)

Intervenants : DAOUK Hazem (Cornell University)

The skewness of the conditional return distribution plays a significant role in financial theory and practice. This paper examines whether conditional skewness of daily aggregate market returns is predictable and investigates the economic mechanisms underlying this predictability. In both developed and emerging markets, there is strong evidence that lagged returns predict skewness; returns are more negatively skewed following an increase in stock prices and returns are more positively skewed following a decrease in stock prices. The empirical evidence shows that the traditional explanations such as the leverage effect, the volatility feedback effect, the stock bubble model (Blanchard and Watson, 1982), and the fluctuating uncertainty theory (Veronesi, 1999) are not driving the predictability of conditional skewness at the market level. The relation between skewness and lagged returns is more consistent with the Cao, Coval, and Hirshleifer (2002) model. Our findings have implications for future theoretical and empirical models of time-varying market return distributions, optimal asset allocation, and risk management.

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Understanding Stock Return Volatility

Auteurs : OSAMBELA Emilio (Swiss Finance Institute & University of Lausanne)

Intervenants : OSAMBELA Emilio (Swiss Finance Institute & University of Lausanne)

This article studies the effect of limited commitment on stock return volatility in a dynamic general equilibrium economy populated by investors with heterogeneous beliefs. Due to heterogeneity of beliefs investors disagree about the fundamentals, introducing an additional risk factor denoted sentiment risk. Limited commitment introduces an endogenous solvency constraint which scales up sentiment risk every time it binds, which is labelled solvency risk. The equilibrium market price of risk which drives the short-run stock return volatility is conformed by three components: endowment risk, sentiment risk, and solvency risk. The three components are persistent, in line with volatility clustering or GARCH effects. The solvency risk component in the market price of risk is novel, and it is the main contribution of the paper. It is related to the optimal exercise boundary of an American-style contingent claim, and exhibits a markedly different pattern with transient persistence according to the binding of solvency constraints. This is consistent with two-component volatility models. Due to solvency risk, the correlation between stock return volatility and stock expected returns depends on the direction of disagreement of the population facing limited commitment, which may be relatively optimistic (positive correlation) or relatively pessimistic (negative correlation). This may explain the conflicting empirical evidence in the correlation between stock return volatility and stock expected returns.

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The Conditional Relation between Fama-French Betas and Return

Auteurs : KOCH Stefan & WESTHEIDE Christian(University of Bonn)

Intervenants : WESTHEIDE Christian (University of Bonn)

Although the CAPM has been empirically rejected, many previous papers find a conditional relation between market beta and return. In this study, we apply the conditional approach to the predominant model in asset pricing, the Fama-French three-factor model. Our results reveal that the size and book-to-market betas retain their explanatory power once the conditional nature of the relation between betas and return is taken into account. While other papers stop their analysis at this point, we derive a procedure to test if beta risk is priced within the conditional approach and show that the adjusted test leads to qualitatively identical results to the widely used Fama-MacBeth test.

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