Li, Yan. 2009. Essays
On Asset Pricing Models: Theories And Empirical Tests. Doctoral
Dissertation, Cornell University.
This dissertation contains
three chapters. Chapter one proposes a nonparametric method to evaluate the
performance of a conditional factor model in explaining the cross section of
stock returns. There are two tests: one is based on the individual pricing
error of a conditional model and the other is based on the average pricing
error. Empirical results show that for value-weighted portfolios, the
conditional CAPM explains none of the asset-pricing anomalies, while the
conditional Fama-French three-factor model is able to account for the size
effect, and it also helps to explain the value effect and the momentum effect.
From a statistical point of view, a conditional model always beats a
conditional one because it is closer to the true data-generating process.
Chapter two proposes a general equilibrium model to study the implications of
prospect theory for individual trading, security prices and trading volume. Its
main finding is that different components of prospect theory make different
predictions. The concavity/convexity of the value function drives a disposition
effect, which in turn leads to momentum in the cross-section of stock returns
and a positive correlation between returns and volumes. On the other hand, loss
aversion predicts exactly the opposite, namely a reversed disposition effect
and reversal in the cross-section of stock returns, as well as a negative
correlation between returns and volumes. In a calibrated economy, when prospect
theory preference parameters are set at the values estimated by the previous
studies, our model can generate price momentum of up to 7% on an annual basis.
Chapter three studies the role of aggregate dividend volatility in asset
prices. In the model, narrow-framing investors are loss averse over
fluctuations in the value of their financial wealth. Persistent dividend
volatility indicates persistent fluctuation in their financial wealth and makes
stocks undesirable. It helps to explain the salient feature of the stock market
including the high mean, excess volatility, and predictability of stock returns
while maintaining a low and stable risk-free rate. Consistent with the data,
stock returns have a low correlation with consumption growth, and Sharpe ratios
are time-varying.
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