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Abstract
Using more stringent test assets and more formal model diagnostic tools, the first essay demonstrates the importance of higher-order comoment risks in asset pricing by assessing the performance of the most commonly used asset pricing models with and without these risks incorporated. Specifically, we find that higher-order comoment risks help the Fama and French serial pricing kernels to be closer to the admissible pricing kernel and that the newly developed Fama and French five-factor model (Fama and French, 2015), when augmented by the quadratic and cubic terms of the market return and with momentum incorporated, requires the least adjustment to be admissible.
The idiosyncratic volatility puzzle, first found and put forward by Ang, Hodrick, Xing, and Zhang (2006), is the empirical phenomenon that stocks with high idiosyncratic volatilities relative to the Fama and French (1993) three-factor model tend to have abnormally low returns in the subsequent month. The second essay investigates this puzzle in a setting of factor models with a more complete set of well-recognized risk factors incorporated. Our results show that missing factors in the Fama and French three-factor model are the culprits for the puzzle and higher-order comoment risk factors are the principal ones. After controlling for these potential missed factors, the idiosyncratic volatility anomaly disappears.
The beta anomaly is the empirical phenomenon that stocks with high (low) betas have negative (positive) alphas. That is, returns of high-beta stocks are too low relative to returns of low-beta stocks. In the third essay, we demonstrate that stock’s quality is a key driver of the beta anomaly. The beta anomaly disappears when beta-sorted portfolios are neutralized to stock’s quality. In addition, we find that the beta anomaly exists only when stock’s quality is highly correlated with beta. Moreover, we find that high institutional ownership attenuates, although not eliminate, both the beta anomaly and stock’s quality effect. Finally, we show that stock’s quality plays an important role in the relation between future stock returns and beta.
