The Conditional CAPM does not Explain Asset-Pricing Anamolies

Recent studies suggest that the conditional CAPM might hold, period-by-period, and that time-varying betas can explain the failures of the simple, unconditional CAPM. We argue, however, that significant departures from the unconditional CAPM would require implausibly large time-variation in betas and expected returns. Thus, the conditional CAPM is unlikely to explain asset-pricing anomalies like book-to-market and momentum. We test this conjecture empirically by directly estimating conditional alphas and betas from short-window regressions (avoiding the need to specify conditioning information). The tests show, consistent with our analytical results, that the conditional CAPM performs nearly as poorly as the unconditional CAPM.

Do Wealth Fluctuations Generate Time-varying Risk Aversion? Micro-Evidence on Individuals' Asset Allocation

We use data from the PSID to investigate how households' portfolio allocations change in response to wealth fluctuations. Persistent habits, consumption commitments, and subsistence levels can generate time-varying risk aversion with the consequence that when the level of liquid wealth changes, the proportion a household invests in risky assets should also change in the same direction. In contrast, our analysis shows that the share of liquid assets that households invest in risky assets is not affected by wealth changes. Instead, one of the major drivers of households' portfolio allocation seems to be inertia: households rebalance only very slowly following inflows and outflows or capital gains and losses.

Sizing Up Repo

We measure the repo funding extended by money market funds (MMF) and securities lenders to the shadow banking system, including quantities, haircuts, and repo rates by type of underlying collateral. We find that repo played only a small role in funding private sector assets prior to the crisis, as most repos are backed by Treasury and Agency collateral. Repo with private sector collateral contracts during the crisis, but the magnitude is relatively insignificant compared with the contraction in asset-backed commercial paper (ABCP). While relatively small in aggregate, the contraction in repo particularly affected key dealer banks with large exposures to private sector securities, which then had knock-on effects on security markets, and led these dealer banks to resort to the Fed's emergency lending programs. We also find that haircuts in MMF-to-dealer repo rise less than the dealer-to-dealer or dealer-to-hedge fund repo haircuts reported in earlier papers. This finding suggests that the contraction in repo led dealers to take defensive actions, given their own capital and liquidity problems, raising credit terms to their borrowers. The picture that emerges from these findings looks less like a traditional bank run of depositors and more like a credit crunch among dealer banks.

The Effect of Dividends on Consumption

Classical models predict that the division of stock returns into dividends and capital appreciation does not affect investor consumption patterns, while mental accounting and other economic frictions predict that investors have a higher propensity to consume from stock returns in the form of dividends. Using two micro data sets, we show that investors are indeed far more likely to consume from dividends than capital gains. In the Consumer Expenditure Survey, household consumption increases with dividend income, controlling for total wealth, total portfolio returns, and other sources of income. In a sample of household investment accounts data from a brokerage, net withdrawals from the accounts increase one-for-one with ordinary dividends of moderate size, controlling for total portfolio returns, and also increase with mutual fund and special dividends. We comment on several potential explanations for the results.

A Skeptical Appraisal of Asset-Pricing Tests

It has become standard practice in the cross-sectional asset-pricing literature to evaluate models based on how well they explain average returns on size- and B/M-sorted portfolios, something many models seem to do remarkably well. In this paper, we review and critique the empirical methods used in the literature. We argue that asset-pricing tests are often highly misleading, in the sense that apparently strong explanatory power (high cross-sectional R2s and small pricing errors) in fact provides quite weak support for a model. We offer a number of suggestions for improving empirical tests and evidence that several proposed models don%u2019t work as well as originally advertised.