Equity Premium with Habits, Wealth Inequality and Background Risk

In an exchange economy with endowment inequality, we investigate how preferences with external habits affect the equity risk premium. We show that the dynamics of external additive habits with wealth inequality are complex when a background risk is present. It is ambiguous whether wealth inequality will increase or decrease the equity premium even when the income uncertainty is low. This result extends literature by suggesting that wealth inequality has a small role in explaining asset pricing puzzles.

Firm efficiency and the investment anomalies

PurposeThe purpose of this paper is to investigate whether firm efficiency can explain the investment anomaly. The investment anomaly refers to the persistent negative relation between firm growth and future risk-adjusted returns. When firms grow by investing heavily, the market often takes the growth as positive news initially but will correct prices downward subsequently if the firms lack skills to materialize value from the investments.Design/methodology/approachThe author conducts portfolio sorting and Fama–Macbeth regression analyses with three different measures of efficiency and four variables for firm investment: net stock issuance (NSI), total asset growth (dAA), fixed asset and inventory growth (IA) and net operating assets (NOA).FindingsThe author finds that the NSI, dAA and IA anomalies are concentrated in firms with low overall efficiency. In addition, there is strong evidence that manager-driven efficiency is closely related to the NSI anomaly and limited evidence that NOA efficiency plays a role in the NSI, IA and NOA anomalies.Originality/valueThe research contributes to the literature by employing advanced efficiency measures developed by Demerjian et al. (2012) to resolve extant asset pricing puzzles. Also, the findings offer important implications for corporate managers and investors by demonstrating the effect of firm investments and efficiency on future profitability of stocks.

Variance Risk Premia, Asset Predictability Puzzles, and Macroeconomic Uncertainty

This article reviews the predictability evidence on the variance risk premium: ( a) It predicts significant positive risk premia across equity, bond, currency, and credit markets; ( b) the predictability peaks at few-month horizons and dies out afterward; ( c) such a short-run predictability is complementary to the long-run predictability offered by the price-to-earnings ratio, forward rate, interest differential, and leverage ratio. Several structural approaches based on the notion of economic uncertainty are discussed for generating these stylized facts about the variance risk premium, which has broad implications for various empirical asset pricing puzzles.