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Pricing Intertemporal Risk When Investment Opportunities Are Unobservable

Published online by Cambridge University Press:  14 September 2018

Scott Cederburg
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Abstract

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The intertemporal capital asset pricing model (ICAPM) predicts that an unobservable factor capturing changes in expected market returns should be priced in the cross section. My Bayesian framework accounts for uncertainty in the intertemporal risk factor and gauges the effects of prior information about investment opportunities on model inferences. Whereas an uninformative prior specification produces weak evidence that intertemporal risk is priced, incorporating prior information about market-return predictability generates a large space of ex ante reasonable priors in which the estimated intertemporal risk factor is positively priced. Overall, the cross-sectional tests reject the capital asset pricing model (CAPM) and indicate support for the ICAPM.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 54 , Issue 4 , August 2019 , pp. 1759 - 1789
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Footnotes

1

I thank David Bates, Matt Billett, David Brown, Jennifer Conrad (the editor), Phil Davies, Robert Dittmar, Redouane Elkamhi, Massimo Guidolin (the referee), Huseyin Gulen, Arthur Korteweg, Chris Lamoureux, Mike O’Doherty, B. Ravikumar, Rick Sias, Ashish Tiwari, Paul Weller, and Yu Yuan; seminar participants at the University of Arizona, the University of Connecticut, Georgia Tech, Indiana University, the University of Missouri, Purdue University, Rutgers University, and the University of Texas at Dallas; and participants at the Financial Management Association Doctoral Student Consortium, the 2010 Center for Research in Security Prices Forum, the 2011 Eastern Finance Association Conference, and the 2011 Midwest Finance Association Conference for helpful comments and suggestions. An allocation of computer time from High Performance Computing (HPC) at the University of Arizona is gratefully acknowledged. Any errors are my own.

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