Production-based measures of risk for asset pricing pdf

The book gives some practical advice on how a small and mediumsized bank can start to develop its own al risk management system by focusing on the interest rate risk and liquidity risk management policy and the measurement of these risks. At one end, the capital asset pricing model measures the market risk with a beta measured relative to a market portfolio, and at the other are multifactor models that measure market risk using multiple betas estimated relative to different factors. At the same time, oil inventories increase and oil consumption falls. Optimal investment, growth options, and security returns. The marginal rate of transformation implies a novel macrofactor asset pricing model. Our paper shows that including such taxes can have a signicant impact on both the real economy and asset prices. I am very grateful to the members of my dissertation committee, john cochrane chair, john heaton, monika piazzesi, and pietro veronesi for many helpful discussions.

While the capital asset pricing model capm explains how investors should act and price risk, empirical research has shown that investors often act differently than predicted by capm. It derives a pricing kernel based on the 2 see liew and vassalou 2000 and vassalou 2003 for recent applications of this approach to crosssectional asset pricing. In some cases, ranking targets or thresholds may be established. November 30, 2015 abstract we propose a novel approach to measuring rmlevel risk exposures and costs of equity. Section 2 presents the productionbased asset pricing model. The consumptionbased asset pricing model is introduced in section 2. Under general equilibrium theory prices are determined through market pricing by supply and demand. Cochrane 1996 nds that a simple production based asset pricing model that relates asset returns to returns on aggregate investment performs as well as the capm and the chen, ross and roll factor model and outperforms the simple consumption based model. Gomes university of pennsylvania and cepr amir yaron university of pennsylvania and nber lu zhang university of rochester and nber we use a productionbased asset pricing model to investigate whether financing constraints are quantitatively important for the crosssection. These models endogenize consumption and cash ows and o er a deeper understanding of the links between stock prices and the real economy. Rf, is described by the sensitivities of its returns to the market. Production based asset pricing term structure abstract this paper considers the term structure of interest rates implied by a production based asset pricing model in which the fundamental drivers are investment in equipment and structures as well as inflation. Using a flexible representation of firms production technology, producers. However, the reconciliation of asset markets with aggregate quantities has proved to be a challenge for dsge models.

Beta measures the amount of systematic risk an individual security or an industrial sector has relative to the whole stock market. Lecture notes on advanced corporate financial risk management john e. It will turn out that the most important characteristic is the risk of an asset. Here asset prices jointly satisfy the requirement that the quantities of each asset supplied and the quantities demanded must be equal at that price so called market clearing. This work ts into the line of production based models of asset pricing, that have until recently struggled to account for unconditional moments of asset prices without sacri cing too much of a t of macroeconomic variables. An exception is veronesi 2000, who examines the effect of information quality on the equity premium in a lucas asset pricing model that also features an intangible but unambiguous signal. The intercept, j, is known as treynors alpha and represents the sustained economic pro. A stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation inferred from producers firstorder conditions.

A model of timevarying risk premia with habits and production ian dewbecker duke university february 20, 2014 abstract this paper builds on the productionbased asset pricing literature to generate return predictability in general equilibrium. Oil volatility risk lin gao, ste en hitzemann, ivan shaliastovich, and lai xu july 2018 abstract an increase in oil price volatility predicts a decline in economic growth, controlling for market volatility and business cycle variables. The marginal rate of transformation implies a novel macrofactor asset pricing model that does a reasonable job explaining the crosssectional variation in average stock returns with. Evaluating the specification errors of asset pricing models. Theory and applications is a part of the princeton series in finance. Evaluating asset pricing implications of dsge models. The framework for the analysis is a real business cycle model with two types of agents. T1 productionbased measures of risk for asset pricing. An overview asset liability management alm can be defined as a mechanism to address the. I develop a novel procedure to measure the marginal rates of transformation in practice from industry output and price data.

Among the many issues raised by recent work in asset pricing, two appear to be. Thus, im is the covariance risk of asset i in m measured relative to the average covariance risk of assets, which is just the variance of the market return. Asset pricing with liquidity risk faculty and research. The pq measure for pricing in a sset liability management marcel t. Productionbased measures of risk for asset pricing, 2010, journal of monetary economics, 572, 146163.

Pdf productionbased measures of risk for asset pricing. The marginal rate of transformation implies a novel macrofactor asset pricing model that does a reasonable job explaining the crosssectional variation in average stock returns with plausible. Implications for the crosssection of returns, journal of finance, american finance association, vol. The marginal rate of transformation implies a novel macrofactor asset pricing model that does a reasonable job explaining the crosssectional variation in average stock returns with plausible parameter values. Pogue1 today, most students of financial management would agree that the treatment of risk is the main element in financial decision making. An introduction to risk and return concepts and evidence by franco modigliani and gerald a. We conclude that the liquidity risk indeed appears to be priced. Asset pricing with concentrated ownership of capital and.

Oosterlee 2,3 1 ortec finance, 3011 xb rotterdam, the netherlands. Review the historical record and the concept of the equity market risk premium. Criticism of capm and beta versus other risk measures. Topics in asset pricing in the absence of undervalued investments, longonly positons cannot generate performance. Asset pricing implications bernard herskovicy job market paper z january 22, 2015 abstract this paper studies asset pricing in a multisector model in which sectors are connected to each other through an inputoutput network. Productionbased measures of risk for asset pricing sciencedirect. Topics in asset pricing hebrew university of jerusalem. The slope of this line, j, or simply beta, is perhaps the most commonly used measure of equity risk.

Measuring risk and risk aversion june 20, 2006 asset pricing. The marginal rate of transformation implies a novel macrofactor asset pricing model that does a reasonable. A stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation. Changes in the structure of the network are sources of systematic risk re ected in equilibrium. Firm characteristics, consumption risk, and firmlevel risk exposures robert f. Productionbased measures of risk for asset pricing frederico beloy december 21, 2009 abstract a stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation inferred from producers rstorder conditions. Mar 29, 2020 production based measures of risk for asset pricing, 2010, journal of monetary economics, 572, 146163. This proposition shows that a macrofactor asset pricing model follows from a production based asset pricing setup. Pdf supplementary material for productionbased measures. Return on the risk free asset the return that an investor receives on a safe asset that is free from credit risk what do investors usually use as the risk free rate. Asset pricing implications of firms financing constraints joa. This logic led him to develop the implications of a production based asset pricing model in which covariances of asset returns with macroeconomic measures of investment are important risk factors. The model matches the average yield curve up to fiveyear maturity almost perfectly.

In either case, though, the bank has to measure the risk exposure and formulate strategies to minimise or mitigate risk. In the context of the capital asset pricing model capm the relevant risk is a. Those papers do not consider any type of capital income taxes. Hou, xue, and zhang 2015 measure investmenttocapital, ia, as the annual. Zin preferences to generate movements in risk aversion. Productionbased measures of risk for asset pricing by frederico belo, bob goldstein, joao gomes, francois gourio, luigi guiso, lars hansen, boyan jovanovic, christian julliard, xiaoji lin, stavros panageas, andrew patton, ioanid rosu, nikolai roussanov, nick souleles, ana vitorino, zhenyu wang, amir yaron, motohiro yogo and jianfeng yu. Belo, frederico, 2010, productionbased measures of risk for asset pricing, journal of monetary economics. Pdf introduction to asset pricing and portfolio performance. Bibliography includes bibliographical references and index. Risk aversion, the labor margin, and asset pricing in dsge. In the asset pricing model of bansal and yaron 2004, an increase in aggregate volatility lowers asset prices and, importantly, shocks to volatility carry a separate risk premium. An overview of asset pricing models university of bath bath. Mariano massimiliano croce abstract this study examines the intertemporal distribution of productivity risk. Less directly susceptible to quantification, but often of comparable weight, are the nonfinancial risks noted in the table brand, reputation, culture, etc.

Article pdf available in journal of monetary economics 66 may 2012 with 295 reads how we measure reads. Evaluating alternative methods of asset pricing based on the overall magnitude of pricing errors, finance research letters, elsevier, vol. Frederico belo, production based measures of risk for asset pricing, journal of monetary economics, 57, 2, 146, 2010. Tuzel 2010 finds that firms real estate holdings are positively related to their future equity returns because slower depreciation of structures makes real estate harder to adjust, and increases firms exposure to aggregate shocks.

In our study, we consider two risk measures which can be applied in asset pricing. Focusing on postwar us data, i show that the conditional mean of productivity growth is timevarying and extremely persistent. A growing literature in macroeconomics also highlights the e. The examination of the intertemporal distribution of us productivity risk suggests that the conditional mean of productivity growth is an important determinant of macro quantities and asset prices. Productionbased measures of risk for asset pricing by frederico. Even by using the arrowpratt measure of risk aversion, the utility function has to be known to. Risk attribution and portfolio performance measurementan. A stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation of output across states of nature, inferred from the producers first order conditions. N2 a stochastic discount factor for asset returns is recovered from equilibrium marginal rates of transformation inferred from producers firstorder conditions. Indeed, avramov, cheng, and hameed 2016 show that even the top decile of actively managed.

Productionbased measures of risk for asset pricing core. Productionbased measures of risk for asset pricing 2010. Production based asset pricing framework some numbers figure. We introduce two new features into a standard production based equilibrium. Disaster risk and its implications for asset pricing. Differences exist, however, between different models in how to measure this market risk. These models are born out of modern portfolio theory, with the capital asset pricing. Cochrane abstract this paper describes a production based asset pricing model. Finally, the empirical failure of the capm and the theoretical appeal of multifactor models led fama and french 1992, 1993, 1995, 1996 to develop a.

The power law exponents for assets, in their view, provide investors with more realistic risk measures for these assets. Beta coefficient has been the classic measure of risk in equilibrium based asset pricing models. Journal of risk and financial management article between p and q. An overview of asset pricing models andreas krause university of bath school of management phone. A risk asset is any asset that carries a degree of risk. Firm characteristics, consumption risk, and firmlevel risk. Chapter 9 the capital asset pricing model flashcards. While our paper fits within the third asset pricing approach, it is fundamentally different from the other productionbased asset pricing papers. The last step in the development of the sharpelintner model is to use the. Blackscholes option pricing is the classic example of this approach. If unfavorable redistributions become more likely when productivity is low andor uncertainty is high e. Asset pricing implications of firms financing constraints. A model of timevarying risk premia with habits and production.

Treasury bills because there is an underlying assumption that the u. This way of writing the pricing relation is called risk neutral valuation because it has the same form as the value of a risky asset in a market where investors are risk neutral. Citeseerx document details isaac councill, lee giles, pradeep teregowda. The market has a beta of 1, and it can be used to gauge the risk of a security. Using a simple consumptionbased asset pricing model that explains nearly twothirds of the variation in average. Tail risk consumption based asset pricing models the discount factor representation of asset pricing models the equity premium puzzle the risk free rate puzzle the epsteinzin preferences long run risk habit formation prospect theory 3 professor doron avramov. June 24 2017 frederico belo us bancorp professor in.

Production based measures of risk for asset pricing, journal of monetary economics, elsevier, vol. Productionbased asset pricing and the link between stock. Recently, with the advance of a longrun risk theory in the eld of 1. Higher j implies greater covariance with market return. The capm measures an asset risk as the covariance of its return with the market portfolio return.

In relative pricing we infer an asset s value given the prices of some other asset. We therefore provide one of the first quantitative frameworks to assess the magnitudes of both the loss of investor welfare and the reduction in market value due to imperfect investor protection. Although the risk measure of beta in the capital asset pricing model seems to survive this major deciency, it su. Supplementary material for productionbased measures of. Productionbased asset pricing, production under uncertainty. Risk asset generally refers to assets that have a significant degree of price volatility, such as equities, commodities, highyield bonds, real estate, and currencies. Although the exact specification of the marginal rate of transformation in proposition 1 is new, its specification is closely related to other popular empirical macrofactor asset pricing models such as cochrane 1996 and li et. Rather than using some inflation measure we subtract a benchmark asset. Production based asset pricing and the link between stock returns and economic fluctuations john h. It is analogous to the standard consumption based model, but it uses producers and production functions in the place of consumers and utility functions.

Figures xiiitables xvpreface xviipart i static portfolio choice and asset pricing1 choice under uncertainty 31. The reliability of capital asset pricing model on valuation. This chapter explores these criticisms, alternative measures of risk, and the other methods used to estimate the cost of equity capital. Productionbased measures of risk for asset pricing by. A pure productionbased asset pricing model wharton finance. It is therefore surprising that so little attention has been paid to computing this coe. Productionbased measures of risk for asset pricing article in journal of monetary economics 572.