Asset Pricing Zheng Zhenlong Price change: cash flow or discount rate? 06:49 1

Asset Pricing Zheng Zhenlong Why do prices vary so much?

Asset Pricing Zheng Zhenlong

Asset Pricing Zheng Zhenlong Introduction 1970s view:  Expected returns don’t move much over time — stocks are unpredictable.  Prices move on news of cashflow (dividend).  CAPM works pretty well.  Beta derives from the covariance of cashflows with market cashflows. 06:49

Asset Pricing Zheng Zhenlong Introduction All are dramatically different now. 1. Expected returns move a lot over time — stocks are predictable. (Long run, business cycle correlation) 2. Prices move on news of discount rate changes. 3. We understand the cross-section with multifactor models. (a) A larger number of characteristics other than beta are associated with expected returns (b) To the extent we understand those patterns, expected returns line up with nonmarket betas

Asset Pricing Zheng Zhenlong Introduction 4. Betas derive from the covariance of discount rates with market discount rates. 5. Facts are pushing us to the “risk premium” view of the world, as opposed to the “constant expected return, cashflow” view from the 1970s. 6. These are the facts underlying theoretical modeling.

Asset Pricing Zheng Zhenlong Old Facts

Asset Pricing Zheng Zhenlong New View of facts

Asset Pricing Zheng Zhenlong Why D/P forecasts long horizon returns?

Asset Pricing Zheng Zhenlong Predictability of Dividend growth P/D “should” forecast a dividend rise. Price high relative to current dividends should mean that future dividends will be higher. Dividend growth is not predictable! The point estimates are the “wrong” sign!

Asset Pricing Zheng Zhenlong Do “low” prices mean / reveal high returns?

Asset Pricing Zheng Zhenlong “Predictability” ↔ time-varying expected returns

Asset Pricing Zheng Zhenlong Inefficiency? Does this mean markets are “inefficient”? Is this an invitation to “buy low and sell high?” Not necessarily. Time varying risk premia are possible. Are expected returns higher in good times or in bad times? (Bad, why?) business-cycle related time-varying risk premium is certainly possible.

Asset Pricing Zheng Zhenlong Campbell-Shiller linearization of the one-period return 小写字母代表大写字母的对数 Intuition: higher returns come from higher prices (higher valuations p-d), lower initial prices, or higher dividends.

Asset Pricing Zheng Zhenlong The Campbell-Shiller present value identity If both Δd and r are unforecastable, p−d is constant. If p-d varies at all, something must be forecastable. The fact that d-p varies means that we do not live in an iid world. (Plus no bubbles)

Asset Pricing Zheng Zhenlong

Asset Pricing Zheng Zhenlong A Pervasive Phenomenon Stocks. Dividend yields forecast returns, not dividend growth. Treasuries. A rising yield curve signals better 1-year returns for long-term bonds, not higher future interest rates. Fed fund futures signal returns, not changes in the funds rate. Bonds. Much variation in credit spreads over time and across firms or categories signals returns, not default probabilities. Foreign exchange. International interest rate spreads signal returns, not exchange rate depreciation. Houses. High price/rent ratios signal low returns, not rising rents or prices that rise forever.

Asset Pricing Zheng Zhenlong

Asset Pricing Zheng Zhenlong Common element: business cycle low prices, high returns in recessions. High prices, low returns in booms

Asset Pricing Zheng Zhenlong Multivariate Challenges: More variables

Asset Pricing Zheng Zhenlong Understanding prices: short and long- run forecasts Cay: 消费财富比率

Asset Pricing Zheng Zhenlong The cross section 5

Asset Pricing Zheng Zhenlong Value effect and factor

Asset Pricing Zheng Zhenlong Value (size, and bond factors)

Asset Pricing Zheng Zhenlong The Multidimensional Challenge  (Market, value, size), momentum, accruals, equity issues, beta-arbitrage, credit risk, bond & equity market timing, carry trade, put writing, “liquidity provision,” Which of these are independently important for E(Re )? (“multiple regression”) 2. Does E(Re ) spread correspond to new factors? 3. Do we need all the new factors? Or again, fewer factors than E(Re ) characteristics? 4. Why do prices move? –Long run.  How to approach such a highly multidimensional problem?

Asset Pricing Zheng Zhenlong Asset Pricing on Characteristics/Uni…cation 1. Portfolio sorts are really cross-sectional regressions

Asset Pricing Zheng Zhenlong Asset Pricing on Characteristics/Uni…cation

Asset Pricing Zheng Zhenlong Theory classifi…cation

Asset Pricing Zheng Zhenlong Consumption/habits

Asset Pricing Zheng Zhenlong Investment and Q

Asset Pricing Zheng Zhenlong Challenges for theories  Pervasive, coordinated risk premium in all markets, especially unintermediated  Mean returns are associated with comovement.  Strong correlation with macroeconomics

Asset Pricing Zheng Zhenlong “Arbitrages”

Asset Pricing Zheng Zhenlong “Arbitrages”

Asset Pricing Zheng Zhenlong Price and volume in the tech “bubble

Asset Pricing Zheng Zhenlong Bonds ： –a cautionary tale

Asset Pricing Zheng Zhenlong Stocks (your endowment) in the crisis

Asset Pricing Zheng Zhenlong Alphas, betas, and performance evaluation A hedge fund manager said, “‘Exotic beta’ is my alpha. I understand those systematic factors and know how to trade them. My clients don’t.”

Asset Pricing Zheng Zhenlong Conclusion  Discount rates vary over time and across assets a lot more than you thought  Empirical: how. Theoretical: why. Applications: at all.  We’’ve only started  How do you ask the right question?

Asset Pricing Zheng Zhenlong