Asset Pricing with–and without–garbage.

Asset Pricing with–and without–garbage.

August 12, 2016 Macroeconomics Research, Uncategorized

Last updated on January 1st, 2017 at 07:47 pm

Print Friendly

If you are into consumption-based asset pricing theory and the associated empirical attempts to reconcile the theory with the data from the realized equity premium, garbage is a fascinating subject.

So let’s talk about asset pricing both with–and without–garbage.

garbage

First the original paper on asset pricing with garbage.

The original paper by an old friend and former PhD buddy, Alexi Savov.

Asset Pricing with Garbage

A new measure of consumption, garbage, is more volatile and more correlated with stocks than the canonical measure, National Income and Product Accounts (NIPA) consumption expenditure. A garbage-based consumption capital asset pricing model matches the U.S. equity premium with relative risk aversion of 17 versus 81 and evades the joint equity premium-risk-free rate puzzle. These results carry through to European data. In a cross-section of size, value, and industry portfolios, garbage growth is priced and drives out NIPA expenditure growth.

and now a new paper…

Asset Pricing without Garbage

This paper provides an explanation for why garbage implies a much lower relative risk aversion in the consumption-based asset pricing model than National Income and Product Accounts (NIPA) consumption expenditure: unlike garbage, NIPA consumption is filtered to mitigate measurement error. I apply a simple model of the filtering process that allows one to undo the filtering inherent in NIPA consumption. “Unfiltered NIPA consumption” well explains the equity premium and is priced in the cross-section of stock returns. I discuss the likely properties of true consumption (i.e., without measurement error and filtering) and quantify implications for habit and long-run risk models.

If you aren’t into really geeking out then consider this post a “garbage in, garbage out” situation. har har…

PS. How about those Olympians last night? Incredible performances in the pool and the gym!!!


Note: This site provides no information on our value investing ETFs or our momentum investing ETFs. Please refer to this site.


Join thousands of other readers and subscribe to our blog.


Please remember that past performance is not an indicator of future results. Please read our full disclaimer. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alpha Architect, its affiliates or its employees. This material has been provided to you solely for information and educational purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Alpha Architect to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission from Alpha Architect.




About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.