Asset pricing and energy consumption risk

This article, Part 1 of 2, reviews the classical origins, development, and tests of consumption-based asset pricing theory, focusing mainly on the first two decades from 1976 to 1998. Starting with the original consumption capital asset pricing model (CCAPM) derivations, we review both theory and subsequent tests and provide some new applications. The consumption aggregation theorem and CCAPM are derived, and optimal consumption and portfolio strategies are discussed. The term structure of interest rates is derived from the term structures for expected growth, volatility, and inflation. Time aggregation biases in consumption betas as well as the usefulness of the “consumption-mimicking portfolio” are also derived. In addition to various empirical tests, models and tests of limited participation in asset markets as well as models of incomplete markets are presented. When certain measurement issues are taken into account, the CCAPM performs better than the original CAPM and nearly as well as the Fama-French three-factor model.

PurposeThis paper seeks to reconsider the Euler equation of the Consumption Capital Asset Pricing Model (CCAPM), to derive a regression‐based model to test it, and to present evidence that the model is consistent with reasonable values for the coefficient of relative risk aversion (CRRA). This runs contrary to the findings of the literature on the equity premium puzzle, but is in agreement with the literature that estimates the CRRA for the purpose of computing the social discount rate, and is in line with the research on labor supply. Tests based on General Method of Moments (GMM) for the same sample produce results that are extremely disparate and unstable. The paper aims to check and find support for the robustness of the regression‐based tests. Habit formation models are also to be evaluated with regression‐based and GMM tests. However, the validity of the regression‐based models depends critically on their functional forms.Design/methodology/approachThe paper presents empirical evidence that the conventional use of GMM fails because of four pathological features of GMM that are referred to under the general caption of “weak identification”. In addition to GMM, the paper employs linear regression analysis to test the CCAPM, and it is found that the regression residuals follow well‐behaved distributional properties, making valid all statistical inferences, while GMM estimates are highly unstable.FindingsFour unexpected findings are reported. The first is that the regression‐based models are consistent with reasonable values for the CRRA, i.e. estimates that are below 4. The second is that the regression‐based tests are robust, while the GMM‐based tests are not. The third is that regression‐based tests with habit formation depend crucially on the specification of the model. The fourth is that there is evidence that market stock returns are sensitive to both consumption and dividends. The author calls the latter “extra sensitivity of market stock returns”, and it is described as a new puzzle.Originality/valueThe regression‐based models of the CCAPM Euler equation are novel. The comparison between GMM and regression‐based models for the same sample is original. The regression‐based models with habit formation are new. The equity premium puzzle disappears because the estimates of the CRRA are reasonable. But another puzzle is documented, which is the “extra sensitivity of market stock returns” to consumption and dividends together.

This paper analyzes asset prices in a representative agent exchange economy with habit-forming preferences. For a general class of utility indices and endowment processes, the authors characterize the optimal demand for consumption and derive explicit solutions for the interest rate and asset risk premia. They show that consumption smoothness may obtain even when the interest rate is stochastic. The consumption capital asset pricing model may not hold when the endowment process has stochastic coefficients; asset risk premia are larger under mild assumptions. The interest rate depends on the growth in the standard of living. Malliavin calculus is employed in the analysis. Copyright 1991 by The Econometric Society.

New Goods and Asset Prices

SummaryThis paper proposes an empirical asset pricing test based on the homogeneity of the factor risk premia across risky assets. Factor loadings are considered to be dynamic and estimated from data at higher frequencies. The factor risk premia are obtained as estimates from time series regressions applied to each risky asset. We propose Swamy‐type tests robust to the presence of generated regressors and dependence between the pricing errors to assess the homogeneity of the factor risk premia and the zero intercept hypothesis. An application to US industry portfolios shows overwhelming evidence rejecting the capital asset pricing model, and the three and five factor models developed by Fama and French (Journal of Financial Economics, 1993, 33, 3–56; Journal of Financial Economics, 2015, 116, 1–22). In particular, we reject the null hypotheses of a zero intercept, homogeneous factor risk premia across risky assets, and the joint test involving both hypotheses.

The three essays in this dissertation study the impact of corporate liquidity on a firm's value, how corporate liquidity affects the probability of financial distress and equity returns, and whether corporate liquidity represents an idiosyncratic risk, or serves as a priced risk factor.;The first essay examines the relationship between corporate liquidity and equity returns for individual firms. It is found that firms holding more liquid assets have significantly higher equity returns. This positive relationship between corporate liquidity and equity returns is more pronounced among firms with financial constraints. In addition, firms expecting volatile cash flows stock more cash for precautionary purposes and their stock returns are higher relative to those generating stable cash flows. These empirical evidences indicate that the level of corporate liquidity may signal risks faced by companies. Furthermore, more liquid firms tend to have higher market beta, which suggests that corporate liquidity may serve as a risk factor. Finally, Fama-MacBeth two pass regression results show that corporate liquidity contains different information than what is included in other important firm characteristics like size and book-to-market equity ratio.;The second essay further explores the relationship between corporate liquidity and the expected return of stocks at the aggregate level. Asset pricing tests are performed to examine whether the constructed corporate liquidity factor, LMI (Liquid Minus Illiquid), is a risk factor and whether it is systematic and priced. Empirical evidences from multifactor asset pricing models suggest that LMI can still serve as an independent factor and is priced although it shares some common information with the three popular factors MKT, SMB and HML. Moreover, corporate liquidity beta is increased when the macroeconomic condition becomes less favorable, and the corporate liquidity beta is more sensitive to changes in macroeconomic conditions for firms with more corporate liquidity and financial constraints.;The third essay examines how a company's market value can be affected by residual cash, and whether corporate liquidity and negative residual cash can predict bankruptcy. It is shown that deviation from the target or optimal cash is value destructive, which provides support for the tradeoff theory. However, the impact of residual cash on market value of equity is not symmetric: positive residual cash tends to reduce firm value less than negative residual cash. In general, firms with negative residual cash are more likely to experience financial distress since they are smaller, less profitable, generate lower cash flows, and have higher leverage but weaker payoff

Many evaluation techniques typically measure performance as deviations of average returns on actively managed funds from those predicted by some asset pricing model. Empirical evidence, however, has so far suggested that all asset pricing models lack empirical support, implying that the models contain mis-specification errors to various degrees. Evaluating mutual fund performance relative to any of these models thus becomes problematic. In this paper, we propose an approach to performance measurement that emphasizes minimizing explicitly the pricing error associated with an asset pricing function which is employed to compute performance measures. This approach is henceforth called the minimum specification-error (MSE) method. We also discuss the statistical properties for implementing MSE performance measure. To demonstrate the significance of the pricing error confounded in evaluation measurement, we contrast our methodology with the Grinblatt and Titman (1989) period weighting approach and with the empirical implementation of Chen and Knez (1996). We find that the greater the pricing error of passive assets, the larger the performance measures. Given the average pricing error generated from a collection of 163 diverse passive portfolios used in this analysis the performance values assigned to a large number of the funds become statistically and economically insignificant.

Output gap and consumption risk on the cross-section of stock returns in Korea

Asset market equilibrium: A simulation

Consumption Risk Over the Frequency Domain

Achieving the "dual carbon" goal requires the rapid growth of the new energy industry and the proper handling of the relationship between environmental protection and economic growth. To ensure the healthy development of this industry, it is necessary to fully leverage the regulatory role of the government. With the acceleration of energy transformation, China's energy industry is ushering in a historic opportunity to transition from the low-end to the high-end value chain. This article delves into the current status of China's new energy industry and its legal regulatory system, pointing out that despite the rapid development of the new energy sector, it still faces many challenges such as chaotic market order, insufficient technological innovation capabilities, and difficulties in energy consumption. The promulgation of the Energy Law marks significant progress in China's rule of law construction in the energy field, but further improving the regulatory mechanism is an urgent task. Based on the analysis of the current regulatory situation, this article summarizes the main problems and proposes several improvement suggestions, aiming to establish a more scientific and efficient legal regulatory framework, promote the virtuous cycle of the new energy industry, enhance China's competitiveness in the global green and low-carbon economy, and ultimately achieve the goal of harmonious coexistence among the economy, environment, and energy.

Behavorial Finance vs. Portfolio Theory: Is the Rational Investor Dead?

This article presents a pure exchange economy that extends Rubinstein [Bell J. Econ. Manage. Sci., 1976, 7, 407–425] to show how the jump-diffusion option pricing model of Black and Scholes [J. Political Econ., 1973, 81, 637–654] and Merton [J. Financ. Econ., 1976, 4, 125–144] evolves in gamma jumping economies. From empirical analysis and theoretical study, both the aggregate consumption and the stock price are unknown in determining jumping times. By using the pricing kernel, we determine both the aggregate consumption jump time and the stock price jump time from the equilibrium interest rate and CCAPM (Consumption Capital Asset Pricing Model). Our general jump-diffusion option pricing model gives an explicit formula for how the jump process and the jump times alter the pricing. This innovation with predictable jump times enhances our analysis of the expected stock return in equilibrium and of hedging jump risks for jump-diffusion economies.

We augment the standard Consumption Capital Asset Pricing Model (CCAPM) by the growth in money holdings and empirically investigate whether money is helpful for pricing a cross-section of US excess returns. We find that the growth in M2 significantly improves the fit of the CCAPM with R 2s well above 80% in a cross-section with the three Fama–French factors, the momentum portfolio, a contrarian portfolio and two bond portfolios as test assets.

This paper develops a method of using financial data to understand the expected impact of trade policy on welfare and other real variables when the policy has heterogeneous and uncertain impacts on firms. We embed a firm-level specific factors model in a consumption capital asset pricing model to map expected cash-flow movements into expected movements in productivity, wages, and welfare. Using our framework, we find that the U.S.-China trade war caused increases in uncertainty and large declines in U.S. stock prices, expected cash flows, and expected productivity. We estimate that the expected decline in U.S. welfare is 4.9 percentage points.