Asset Pricing Restrictions on Predictability: Frictions Matter

Frans de Roon () and Marta Szymanowska
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Frans de Roon: Department of Finance and CentER, Tilburg University, 5000 LE Tilburg, The Netherlands

Management Science, 2012, vol. 58, issue 10, 1916-1932

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. This paper was accepted by Wei Xiong, finance.

Keywords: time-series predictability; cross-sectional predictability; asset pricing tests; market frictions (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (6)

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