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.
When does Cash-flow Risk Matter to Investors? Evidence from the COVID-19 Pandemic
Abstract: I use the exogenous shock to aggregate consumption caused by the COVID-19 pandemic to examine the importance of cash-flow risk for investors. I find that the industry long-run cash-flow risk predicted which industries performed worst during the pandemic. High cash-flow risk industries experienced abnormally low excess returns and substantially higher risk levels during the first three months of 2020. I use dividend futures data to show that the equity term structure inverted and forward equity yields proliferated after mid-March 2020, which may explain the heightened relevance of cash-flow risk during the pandemic.
Presented at: University of Iowa, Silicon Prairie Finance Webinar: Register Here (upcoming).
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 findings 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