2002
DOI: 10.2139/ssrn.334760
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Estimation and Test of a Simple Model of Intertemporal Capital Asset Pricing

Abstract: A simple valuation model that allows for time variation in investment opportunities is developed and estimated. The model assumes that the investment opportunity set is completely described by two state variables, the real interest rate and the maximum Sharpe ratio, which follow correlated Ornstein-Uhlenbeck processes. The model parameters and time series of the state variables are estimated using data on US Treasury bond yields and inflation for the period January 1952 to December 2000. The estimated state va… Show more

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Cited by 128 publications
(140 citation statements)
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“…Specifically, firm riskiness can increase, in response to an unexpected increase in the FFR, through a rise in the interest burden and the weakening of balance sheets, which can also translate into an increase in the credit spread. 8 This risk-based explanation is consistent with asset pricing models in which the (innovation) in a short-term interest rate (and specifically, the innovation in F F R) is a priced risk factor that helps to explain cross-sectional equity risk premia (Brennan et al, 2004;Petkova, 2006;Lioui and Maio, 2014;Maio and Santa-Clara, 2017). In these multifactor models, the interest rate factor earns a negative price of risk, and thus stocks that have negative interest rate factor loading (that is, negative return responses against positive changes in interest rates) earn a higher risk premium, which translates into higher expected stock returns, relative to stocks that are uncorrelated with short-term interest rates.…”
Section: Introductionsupporting
confidence: 55%
“…Specifically, firm riskiness can increase, in response to an unexpected increase in the FFR, through a rise in the interest burden and the weakening of balance sheets, which can also translate into an increase in the credit spread. 8 This risk-based explanation is consistent with asset pricing models in which the (innovation) in a short-term interest rate (and specifically, the innovation in F F R) is a priced risk factor that helps to explain cross-sectional equity risk premia (Brennan et al, 2004;Petkova, 2006;Lioui and Maio, 2014;Maio and Santa-Clara, 2017). In these multifactor models, the interest rate factor earns a negative price of risk, and thus stocks that have negative interest rate factor loading (that is, negative return responses against positive changes in interest rates) earn a higher risk premium, which translates into higher expected stock returns, relative to stocks that are uncorrelated with short-term interest rates.…”
Section: Introductionsupporting
confidence: 55%
“…Ang and Bekaert (2007) find some predictability of nominal short rates for future aggregate stock returns. Brennan, Wang, and Xia (2004) write down an intertemporal-CAPM model where the real rate, expected inflation, and the Sharpe ratio move around the investment opportunity set. They show that this model prices the cross-section of stocks.…”
Section: Related Literaturementioning
confidence: 99%
“…The nominal risk-free interest rate and the maximum Sharpe Ratio are respectively r ¼ 0.0547 and l ¼ 0.70, equal to the long-run averages in Brennan et al (2004). These authors set the long-run real interest rate to 0.0162 and the long-run inflation to 0.0385, which adds up to 0.0547.…”
Section: Pre-determined Parametersmentioning
confidence: 99%
“…These authors estimate that the real growth trend of US aggregate earnings from 1947 to 2005 is 0.0343, which results in a nominal growth rate of 0.0728 after adding the 0.0385 long-term inflation rate in Brennan et al (2004). After the hostile renegotiation of foreign debt and associated regime change, the nominal growth trend drops to m x ¼ 0:0410.…”
Section: Free Parametersmentioning
confidence: 99%