Essays on Rational Asset Pricing.

Abstract

Essays on Rational Asset Pricing is a collection of essays demonstrating the ability of rational asset pricing theory to explain differences in expected returns across assets. The first two essays analyze the cross-sectional and time-series predictability of returns on commodity futures contracts. Historically, futures have earned average returns similar to those of equities. Nevertheless, they fulfill a different economic function. We find that expected futures returns vary in a systematic way due to differences in consumption risk, similar to the returns on stocks. However, unlike for stocks, demand and supply changes which are related to commodity prices - and therefore consumption - lead short run consumption risk to be important for explaining commodities’ returns but not long run consumption risk. In the third essay, we extend the analysis on predictability by showing how restrictions imposed by asset pricing theory on the measures of predictability change when investors face short sale constraints and transaction costs. Finally, in the last essay we relax the assumption of rational pricing and allow for behavioral biases on the side of the investor to explain mispricing observed in a particular class of securities, reverse convertible bonds.