Time-varying state variable risk premia in the ICAPM

Pedro Barroso; Paul Karehnke; Martijn Boons

doi:10.1016/j.jfineco.2020.07.016

Time-varying state variable risk premia in the ICAPM

Pedro Barroso, Paul Karehnke, Martijn Boons

Research output: Contribution to journal › Article › peer-review

12 Citations (Scopus)

Abstract

We find that the relation between state variables, such as the t-bill rate and term spread, and consumption growth is time-varying. In the cross-section of U.S. stocks, risk premia for exposure to state variables vary over time accordingly. When a state variable predicts consumption strongly relative to its own history, its annualized risk premium increases by 6% (0.4 in Sharpe ratio). This effect implies that risk premia can switch signs and are increasing in the conditional variance of the state variable. These common drivers of time-varying risk premia are consistent with the Intertemporal CAPM. Benchmark factors contain the same conditional expected return effects as state variable risk premia.

Original language	English
Pages (from-to)	428-451
Number of pages	24
Journal	Journal of Financial Economics
Volume	139
Issue number	2
DOIs	https://doi.org/10.1016/j.jfineco.2020.07.016
Publication status	Published - Feb 2021
Externally published	Yes

Keywords

Conditional asset pricing models
Consumption predictability
Intertemporal CAPM
State variables
Time-varying equity risk premia

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10.1016/j.jfineco.2020.07.016

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title = "Time-varying state variable risk premia in the ICAPM",

abstract = "We find that the relation between state variables, such as the t-bill rate and term spread, and consumption growth is time-varying. In the cross-section of U.S. stocks, risk premia for exposure to state variables vary over time accordingly. When a state variable predicts consumption strongly relative to its own history, its annualized risk premium increases by 6% (0.4 in Sharpe ratio). This effect implies that risk premia can switch signs and are increasing in the conditional variance of the state variable. These common drivers of time-varying risk premia are consistent with the Intertemporal CAPM. Benchmark factors contain the same conditional expected return effects as state variable risk premia.",

keywords = "Conditional asset pricing models, Consumption predictability, Intertemporal CAPM, State variables, Time-varying equity risk premia",

author = "Pedro Barroso and Paul Karehnke and Martijn Boons",

note = "Funding Information: We are grateful to Jonathan Lewellen (the referee), Daniel Buncic, Julien Cujean, Andras Fulop, Gleb Gertsman, Andrei Gon{\c c}alves, Bill Schwert (the editor), and seminar participants at the Australasian Finance & Banking Conference, Empirical Finance Workshop in ESSEC, ESSEC Paris, Eurofidai Paris December Finance Meeting, European Economic Association Annual Congress in Lisbon, European Finance Association conference in Lisbon, Nova SBE in Lisbon, and UNSW in Sydney for helpful comments. This work was funded by National Funds through FCT Portugal. Funding Information: ? We are grateful to Jonathan Lewellen (the referee), Daniel Buncic, Julien Cujean, Andras Fulop, Gleb Gertsman, Andrei Gon?alves, Bill Schwert (the editor), and seminar participants at the Australasian Finance & Banking Conference, Empirical Finance Workshop in ESSEC, ESSEC Paris, Eurofidai Paris December Finance Meeting, European Economic Association Annual Congress in Lisbon, European Finance Association conference in Lisbon, Nova SBE in Lisbon, and UNSW in Sydney for helpful comments. This work was funded by National Funds through FCT Portugal. Publisher Copyright: {\textcopyright} 2020 Elsevier B.V.",

year = "2021",

month = feb,

doi = "10.1016/j.jfineco.2020.07.016",

language = "English",

volume = "139",

pages = "428--451",

journal = "Journal of Financial Economics",

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T1 - Time-varying state variable risk premia in the ICAPM

AU - Barroso, Pedro

AU - Karehnke, Paul

AU - Boons, Martijn

N1 - Funding Information: We are grateful to Jonathan Lewellen (the referee), Daniel Buncic, Julien Cujean, Andras Fulop, Gleb Gertsman, Andrei Gonçalves, Bill Schwert (the editor), and seminar participants at the Australasian Finance & Banking Conference, Empirical Finance Workshop in ESSEC, ESSEC Paris, Eurofidai Paris December Finance Meeting, European Economic Association Annual Congress in Lisbon, European Finance Association conference in Lisbon, Nova SBE in Lisbon, and UNSW in Sydney for helpful comments. This work was funded by National Funds through FCT Portugal. Funding Information: ? We are grateful to Jonathan Lewellen (the referee), Daniel Buncic, Julien Cujean, Andras Fulop, Gleb Gertsman, Andrei Gon?alves, Bill Schwert (the editor), and seminar participants at the Australasian Finance & Banking Conference, Empirical Finance Workshop in ESSEC, ESSEC Paris, Eurofidai Paris December Finance Meeting, European Economic Association Annual Congress in Lisbon, European Finance Association conference in Lisbon, Nova SBE in Lisbon, and UNSW in Sydney for helpful comments. This work was funded by National Funds through FCT Portugal. Publisher Copyright: © 2020 Elsevier B.V.

PY - 2021/2

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N2 - We find that the relation between state variables, such as the t-bill rate and term spread, and consumption growth is time-varying. In the cross-section of U.S. stocks, risk premia for exposure to state variables vary over time accordingly. When a state variable predicts consumption strongly relative to its own history, its annualized risk premium increases by 6% (0.4 in Sharpe ratio). This effect implies that risk premia can switch signs and are increasing in the conditional variance of the state variable. These common drivers of time-varying risk premia are consistent with the Intertemporal CAPM. Benchmark factors contain the same conditional expected return effects as state variable risk premia.

AB - We find that the relation between state variables, such as the t-bill rate and term spread, and consumption growth is time-varying. In the cross-section of U.S. stocks, risk premia for exposure to state variables vary over time accordingly. When a state variable predicts consumption strongly relative to its own history, its annualized risk premium increases by 6% (0.4 in Sharpe ratio). This effect implies that risk premia can switch signs and are increasing in the conditional variance of the state variable. These common drivers of time-varying risk premia are consistent with the Intertemporal CAPM. Benchmark factors contain the same conditional expected return effects as state variable risk premia.

KW - Conditional asset pricing models

KW - Consumption predictability

KW - Intertemporal CAPM

KW - State variables

KW - Time-varying equity risk premia

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DO - 10.1016/j.jfineco.2020.07.016

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VL - 139

SP - 428

EP - 451

JO - Journal of Financial Economics

JF - Journal of Financial Economics

IS - 2

ER -

Time-varying state variable risk premia in the ICAPM

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Keywords

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