Finance Without Exotic Risk

Pedro Bordalo, Nicola Gennaioli, Rafael La Porta and Andrei Shleifer

No 33004, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We address the joint hypothesis problem in cross-sectional asset pricing by using measured analyst expectations of earnings growth. We construct a firm-level measure of Expectations Based Returns (EBRs) that uses analyst forecast errors and revisions and shuts down any cross-sectional differences in required returns. We obtain three results. First, variation in EBRs accounts for a large chunk of cross-sectional return spreads in value, investment, size, and momentum factors. Second, time variation in these spreads is predictable, and proxied by predictable time variation in EBRs. This result holds even controlling for scaled price variables, which may capture time varying required return differentials. Third, firm characteristics typically viewed as capturing risk predict disappointment of expectations (and of EBRs). Overall, return spreads typically attributed to exotic risk factors are explained by predictable movements in non-rational expectations of firms’ earnings growth.

JEL-codes: G02 G1 G14 G4 G41 (search for similar items in EconPapers)
Date: 2024-09
New Economics Papers: this item is included in nep-fmk and nep-rmg
Note: AP
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