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Interest Rate Risk and the Cross Section of Stock Returns

Published online by Cambridge University Press:  10 March 2014

Abraham Lioui  and
Paulo Maio
Abraham Lioui
Affiliation:
abraham.lioui@edhec.edu, EDHEC Business School, BP 3116, Nice, Cedex 3 06202, France
Paulo Maio
Affiliation:
paulo.maio@hanken.fi, Department of Finance and Statistics, Hanken School of Economics, Arkadiankatu, 22, Helsinki 00101, Finland.
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Abstract

We derive a macroeconomic asset pricing model in which the key factor is the opportunity cost of money. The model explains well the cross section of stock returns in addition to the excess market return. The interest rate factor is priced and seems to drive most of the explanatory power of the model. In this model, both value stocks and past long-term losers enjoy higher average (excess) returns because they have higher interest rate risk than growth/past winner stocks. The model significantly outperforms the nested models (capital asset pricing model (CAPM) and consumption CAPM (CCAPM)) and compares favorably with alternative macroeconomic models.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 49 , Issue 2 , April 2014 , pp. 483 - 511
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2014 

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