Asset Pricing
Zheng Zhenlong
1
Price change: cash flow or discount rate?
02:57
Asset Pricing
Zheng Zhenlong
Why do prices vary so much?
Asset Pricing
Zheng Zhenlong
Asset Pricing
Zheng Zhenlong
Introduction
• 1970s view:
Expected returns don’t move much over time —
stocks are unpredictable.
Prices move on news of cashflow (dividend).
CAPM works pretty well.
Beta derives from the covariance of cashflows with
market cashflows.
02:57
Asset Pricing
Zheng Zhenlong
Introduction
• All are dramatically different now.
1. Expected returns move a lot over time — stocks are
predictable. (Long run, business cycle correlation)
2. Prices move on news of discount rate changes.
3. We understand the cross-section with multifactor models.
(a) A larger number of characteristics other than beta are
associated with expected returns
(b) To the extent we understand those patterns, expected
returns line up with nonmarket betas
Asset Pricing
Zheng Zhenlong
Introduction
4. Betas derive from the covariance of discount rates with
market discount rates.
5. Facts are pushing us to the “risk premium” view of the
world, as opposed to the “constant expected return, cashflow”
view from the 1970s.
6. These are the facts underlying theoretical modeling.
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Old Facts
•
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New View of facts
•
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Why D/P forecasts long horizon
returns?
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Zheng Zhenlong
Predictability of Dividend growth
• P/D “should” forecast a dividend rise. Price high relative to
current dividends should mean that future dividends will be
higher.
• Dividend growth is not predictable! The point estimates are
the “wrong” sign!
Do “low” prices mean / reveal high
returns?
Asset Pricing
Zheng Zhenlong
“Predictability” ↔ time-varying
expected returns
•
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Zheng Zhenlong
Asset Pricing
Zheng Zhenlong
Inefficiency?
• Does this mean markets are “inefficient”? Is this an invitation
to “buy low and sell high?”
• Not necessarily. Time varying risk premia are possible.
• Are expected returns higher in good times or in bad times?
(Bad, why?) business-cycle related time-varying risk
premium is certainly possible.
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Campbell-Shiller linearization of the
one-period return
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• 小写字母代表大写字母的对数
• Intuition: higher returns come from higher prices (higher
valuations p-d), lower initial prices, or higher dividends.
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The Campbell-Shiller present value
identity
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• If both Δd and r are unforecastable, p−d is constant. If p-d
varies at all, something must be forecastable. The fact that d-p
varies means that we do not live in an iid world. (Plus no
bubbles)
Asset Pricing
Zheng Zhenlong
Asset Pricing
Zheng Zhenlong
A Pervasive Phenomenon
• Stocks. Dividend yields forecast returns, not dividend growth.
• Treasuries. A rising yield curve signals better 1-year returns
for long-term bonds, not higher future interest rates. Fed fund
futures signal returns, not changes in the funds rate.
• Bonds. Much variation in credit spreads over time and across
firms or categories signals returns, not default probabilities.
• Foreign exchange. International interest rate spreads signal
returns, not exchange rate depreciation.
• Houses. High price/rent ratios signal low returns, not rising
rents or prices that rise forever.
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Zheng Zhenlong
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Zheng Zhenlong
Common element: business cycle
• low prices, high returns in recessions. High prices, low
returns in booms
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Multivariate Challenges: More
variables
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Understanding prices: short and longrun forecasts
• Cay:消费财富比率
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Zheng Zhenlong
The cross section
5
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Zheng Zhenlong
Value effect and factor
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Zheng Zhenlong
Value (size, and bond factors)
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Zheng Zhenlong
The Multidimensional Challenge
 (Market, value, size), momentum, accruals, equity issues,
beta-arbitrage, credit risk, bond & equity market timing, carry
trade, put writing, “liquidity provision,”...
1. Which of these are independently important for E(Re )?
(“multiple regression”)
2. Does E(Re ) spread correspond to new factors?
3. Do we need all the new factors? Or again, fewer factors
than
E(Re ) characteristics?
4. Why do prices move? –
Long run.
 How to approach such a highly multidimensional problem?
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Asset Pricing on
Characteristics/Uni…
cation
1. Portfolio sorts are really cross-sectional regressions
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Asset Pricing on
Characteristics/Uni…
cation
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Theory classifi…
cation
•
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Consumption/habits
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Investment and Q
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Zheng Zhenlong
Challenges for theories
 Pervasive, coordinated risk premium in all markets, especially
unintermediated
 Mean returns are associated with comovement.
 Strong correlation with macroeconomics
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“Arbitrages”
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“Arbitrages”
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Price and volume in the tech “
bubble
•
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Bonds： –a cautionary tale
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Stocks (your endowment) in the crisis
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Alphas, betas, and performance
evaluation
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• A hedge fund manager said, “‘Exotic beta’ is my alpha. I
understand those systematic factors and know how to trade
them. My clients don’t.”
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Zheng Zhenlong
Conclusion
 Discount rates vary over time and across assets a lot more
than you thought
 Empirical: how. Theoretical: why. Applications: at all.
 We’
’ve only started
 How do you ask the right question?
Asset Pricing
Zheng Zhenlong