Asset pricing restrictions on predictability

Frictions matter

F.A. de Roon, M. Szymanowska

Research output: Contribution to journalArticleScientificpeer-review

Abstract

U.S. stock portfolios sorted on size; momentum; transaction costs; market-to-book, investment-to-assets, and return-on-assets (ROA) ratios; and industry classification show considerable levels and variation of return predictability, inconsistent with asset pricing models. This means that a predictable risk premium is not equal to compensation for systematic risk as implied by asset pricing theory. We show that introducing market frictions relaxes these asset pricing moments from a strict equality to a range. Empirically, it is not short sales constraints but transaction costs (below 35 basis points) that help to reconcile the observed predictability with linear portfolio return-based factor models, and partly with the durable consumption model. Across the sorts, predictability in industry returns can be reconciled with all models considered with only a 25 basis point transaction cost, whereas for momentum and ROA portfolios, up to 115 basis points are needed.
Original languageEnglish
Pages (from-to)1916-1932
JournalManagement Science
Volume58
Issue number10
Publication statusPublished - 2012

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Predictability
Transaction costs
Friction
Asset pricing
Return on assets
Momentum
Industry
Market frictions
Asset pricing models
Equality
Durables
Industry classification
Book-to-market
Short-sale constraints
Systematic risk
Assets
Risk premium
Return predictability

Cite this

de Roon, F.A. ; Szymanowska, M. / Asset pricing restrictions on predictability : Frictions matter. In: Management Science. 2012 ; Vol. 58, No. 10. pp. 1916-1932.
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de Roon, FA & Szymanowska, M 2012, 'Asset pricing restrictions on predictability: Frictions matter', Management Science, vol. 58, no. 10, pp. 1916-1932.

Asset pricing restrictions on predictability : Frictions matter. / de Roon, F.A.; Szymanowska, M.

In: Management Science, Vol. 58, No. 10, 2012, p. 1916-1932.

Research output: Contribution to journalArticleScientificpeer-review

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