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Habit formation, the cross section of stock returns and the cash-flow risk puzzle

Journal of financial economics, 2010-11, Vol.98 (2), p.385-413 [Peer Reviewed Journal]

ISSN: 0304-405X ;EISSN: 1879-2774 ;DOI: 10.1016/j.jfineco.2010.05.003

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  • Title:
    Habit formation, the cross section of stock returns and the cash-flow risk puzzle
  • Author: Santos, Tano ; Veronesi, Pietro
  • Subjects: Habit Value premium Cross-section Cash-flow risk
  • Is Part Of: Journal of financial economics, 2010-11, Vol.98 (2), p.385-413
  • Description: Non-linear external habit persistence models, which feature prominently in the recent "equity premium" asset pricing and macroeconomics literature, generate counterfactual predictions in the cross-section of stock returns. In particular, we show that in the absence of cross-sectional heterogeneity in firms' cash-flow risk, these models produce a "growth premium," that is, stocks with high price-to-fundamental ratios command a higher premium than stocks with low price-to-fundamental ratios. This implication is at odds with the well-established empirical observation of a "value premium" in the cross-section of stock returns. Substantial heterogeneity in firms' cash-flow risk yields both a value premium as well as most of the stylized facts about the cross-section of stock returns, but it generates a "cash-flow risk puzzle": Quantitatively, value stocks have to have "too much" cash-flow risk compared to the data to generate empirically plausible value premiums.
  • Publisher: Elsevier
  • Language: English
  • Identifier: ISSN: 0304-405X
    EISSN: 1879-2774
    DOI: 10.1016/j.jfineco.2010.05.003
  • Source: RePEc
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