Post on 12-Jan-2016
Eric Falkenstein
Tests are of any theory the framework allowsThere are an infinite number of theories
allowedFramework is untestable
f m m f size small big value value growthi r r r r r r rr
Return Volatility
Small Stocks 17.30% 33.4%
Stocks 13% 20.2%
Corporate Bonds 6.0% 8.7%
Government Bonds 5.70% 9.4%
T-bills 3.90% 3.2%
Brealey and Myers Investments Book
My Dissertation (1994) page 53
Theory that some liked volatility not an equilibrium theory
Pre ‘behavioral finance’ popularityNo fancy empirical test (didn’t use GMM)Makes no sense—arbitrage[I took equity risk premium as given]Theory more important than data
Burned by calendar effects
Ang,, Hodrick, Xing and Zhang (JoF 2009)1980-2003Use Fama French Model
f m m f size small big value value growthi r r r r r r rr
Beta-Low Beta0.5 Beta1.0 Beta1.5 Beta-High
AnnRet 10.8% 11.4% 11.4% 8.2% 4.5%
AnnStdev 13.1% 11.6% 17.4% 26.2% 33.9%
Beta 0.57 0.57 1.04 1.44 1.78
Sophie Ni (2007)Return from Bid-Ask midpoint to expiration-36%??
Moskowitz, and Vissing-Jorgensen (2002)
Penman, Richardson, and Tuna. 2007
Debt/Equity
Expected Returns
rD
rE
Theory
Beta and Returns UnremarkableRuss Wermers JoF 2000 piece (persistence,
turnover)Burton Malkiel JoF 1995 piece (persistence,
alpha)Carhart JoF 1997 (persistence, momentum)
Beta irrelevantThe biggest criticism is not adverse
statements, but neglect
% change in yen+riskprem?yenAUDr r
5.5% 0.3% 5.2%
5.5% 0.3% 1.4%
Return in AUD=Return in Yen+Appreciation in Yen/AUD
% change in currency unpredictable
1990-2008 Dollar Annualized Returns, Standard DeviationsMorgan Stanley Capital International (MSCI)MSCI Emerging Markets Index: 7.3%, 35%MSCI World (Developed) Index: 4.4%, 19%
Dimson, Marsh, Staunton (2005)17 Countries, 1900-2005, Annual Data
No Return Premium to High Yield Bonds over Investment Grade
Merrill High Yield Master II (HOAO) Merrill BBB-AA Index (COCO)
20 HY Funds, 12 IG funds
1% premium from 0.25 to 3 yearsNo premium from 5 to 30 yearsVolatility, Covariance, increasing linearly
Futures return from rollHarvey and Erb (2007) copper, heating oil,
and live cattle were on average in backwardization,
corn, wheat, silver, gold, and coffee were in contango
What covariance, volatility has to do with this ???
Campbell, Hilscher, and Szilagyi (2006) Find high distress firms have lower returns
Source: Author. Data from Moody’s, S&P, Compustat
Longshot biasHorse Track: 1-10 odd horses 3% average return on
investment100-1 odd horses have -86% average returnBias not there in smaller odds, as in baseball
Devany and Walls (1999), 2015 movies from 1984-96
Steve Sharpe and Gene Amromin (2005). People have higher expected returns when they have lower expected volatilities
Most studies find no positive aggregate volatility/return correlation over time
2
, 0
m mf mfE r r a b
a b
IPO has a lot of UncertaintyJay Ritter (see his website). 1980-2008.IPO Returns -3.7% annually below size-
matched firms for first 5 years
Deither, Malloy, and Scherbina (2002). Table 2. Data from 1983-2000.
Data ‘strongly reject the interpretation of dispersion in analysts’ forecasts as a measure of risk’
Turnover of stock a proxy for disagreementHighly correlated with beta
Equity Beta Volatility
Equity options Distressed stock returns Analyst Disagreement Trading Volume IPOs Leverage and stock returns
LotteriesHorse racing
Equity Over time
Across Countries
BBB to B bond returns
FuturesCurrenciesPrivate InvestmentsMoviesMutual FundsLow Odds Sport Bets
Initial story was about total volatilityTotal volatility flat or negatively correlated
with returnBeta flat or negatively correlated with returnunrelated to risk.Volatility, Beta Uncorrelated, negatively
correlated, with ‘true’ betas ???