Fundamental Sources of the Time Variation in Equity Risk Levels

Abstract: What drives the time variation in equity risk? I find that industries with high fundamental cash-flow risk have a higher degree of time variation in excess returns, systematic risk premia and risk-adjusted returns. I propose an asset-pricing model with agents exposed to preference shocks that can explain key asset-pricing patterns related to business cycle. My work suggests that, unlike a habit-formation model, a consumption-based model with preference shocks is useful in determining how cash-flow risk drives the crossectional variation in the empirical distribution of risk and returns observed across US industries.

Presented at: University of Iowa, Melbourne University, Aarhus University, NOVA University, Vrije University, Oxford Finance Job Market Workshop (Saïd Business School), 31st Australasian Finance and Banking Conference in Sydney, Macquarie University in Sydney, the 9th FMCG in Melbourne, the EFMA conference in Milan.

Cash-Flow Risk During Downturns: Industry Response to COVID-19 Pandemic

Preliminary Draft. Comments Welcome.

Abstract: The COVID-19 pandemic has caused a negative shock to aggregate consumption. The central question addressed in this paper is how US industries react to this negative shock. The industry long-term cash-flow risk measured using data until 2018 predicted which US industries will perform the worst during the current COVID-19 pandemic and the 2008-2009 global financial crisis. I show that industries with a high cash-flow risk have experienced abnormally low excess returns, high systematic risk and low risk-adjusted returns during the first three months of 2020. This paper contributes to the recognition of cash-flow risk as an important driver and predictor of equity risk and returns during market downturns.

Explaining the Idiosyncratic Volatility Puzzle with a Bayesian-Updating Model

(with Xuhui (Nick) Pan, Bharat Raj Parajuli)

Abstract: We find that the idiosyncratic volatility (IVOL) puzzle exists only among firms that underperform their benchmark or release negative earnings surprises. We explain these fi ndings using a Bayesian updating model in which agents observe noisy signals about future cash flows. In this setting, high IVOL increases the likelihood of observing earnings surprises. When the noisy surprise is negative, returns exhibit a negative momentum, and the IVOL puzzle emerges. When controlling for relative performance and signal precision, the IVOL puzzle disappears. Our explanation alone can account for up to 75% of the IVOL puzzle, which is more than all other existing theories combined.

The Price of Asymmetric Dependence: International Evidence

(with Jamie Alcock)

Abstract: Asymmetric dependence between stock returns and market returns is significantly priced in international equity returns. Of all the commonly considered factors, asymmetric dependence is the only factor priced in all 38 markets examined. Internationally, investors require additional compensation to hold assets displaying asymmetric dependence. The degree of asymmetric dependence increases faster in countries experiencing stronger growth in their financial markets. Asymmetric dependence is stronger in fast-developing equity markets than in the US market. Our findings support recognition of asymmetric dependence as a risk factor that has significant implications for, inter alia, asset pricing, cost of capital, and performance evaluation of international equities.

Presented at: FMA European Meeting in Kristiansand, Norway, 30th AFBC in Sydney, FIRN Annual Conference in Uluru, FMA Annual Meeting in Boston, Fordham PhD Colloquium in New York