Hostname: page-component-78c5997874-s2hrs Total loading time: 0 Render date: 2024-11-06T11:02:45.409Z Has data issue: false hasContentIssue false

Short-Term Interest Rates and Stock Market Anomalies

Published online by Cambridge University Press:  15 June 2017

Abstract

We present a simple 2-factor model that helps explain several capital asset pricing model (CAPM) anomalies (value premium, return reversal, equity duration, asset growth, and inventory growth). The model is consistent with Merton’s intertemporal CAPM (ICAPM) framework, and the key risk factor is the innovation on a short-term interest rate, the federal funds rate, or the T-bill rate. This model explains a large fraction of the dispersion in the average returns of the joint market anomalies. Moreover, the model compares favorably with alternative multifactor models widely used in the literature. Hence, short-term interest rates seem to be relevant for explaining several dimensions of cross-sectional equity risk premia.

Type
Research Article
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

We thank Francisco Barillas (the referee), Hendrik Bessembinder (the editor), and seminar participants at the 2012 Arne Ryde workshop, the 2012 Finance Down Under Conference, the 2012 Rothschild Caesarea Center Conference, and the 2012 Annual Conference of the Swiss Society for Financial Market Research (SGF) for helpful comments on earlier drafts. We are grateful to Kenneth French, Amit Goyal, Robert Shiller, Robert Stambaugh, and Lu Zhang for making stock market data available. A previous version was titled “The Fed and Stock Market Anomalies.” Maio acknowledges financial support from the Hanken Foundation. Any remaining errors are our own.

References

Adrian, T.; Etula, E.; and Muir, T.. “Financial Intermediaries and the Cross-Section of Asset Returns.” Journal of Finance, 69 (2014), 25572596.Google Scholar
Ang, A., and Bekaert, G.. “Stock Return Predictability: Is It There?Review of Financial Studies, 20 (2007), 651708.Google Scholar
Bali, T. G., and Engle, R. F.. “The Intertemporal Capital Asset Pricing Model with Dynamic Conditional Correlations.” Journal of Monetary Economics, 57 (2010), 377390.Google Scholar
Balvers, R. J., and Huang, D.. “Money and the (C)CAPM.” Journal of Financial and Quantitative Analysis, 44 (2009), 337368.Google Scholar
Basu, S.The Relationship between Earnings Yield, Market Value, and Return for NYSE Common Stocks: Further Evidence.” Journal of Financial Economics, 12 (1983), 129156.CrossRefGoogle Scholar
Belo, F., and Lin, X.. “The Inventory Growth Spread.” Review of Financial Studies, 25 (2011), 278313.Google Scholar
Bernanke, B. S., and Blinder, A. S.. “The Federal Funds Rate and the Channels of Monetary Transmission.” American Economic Review, 82 (1992), 901921.Google Scholar
Bernanke, B. S., and Gertler, M.. “Agency Costs, Net Worth, and Business Fluctuations.” American Economic Review, 79 (1989), 1431.Google Scholar
Bernanke, B. S., and Gertler, M.. “Financial Fragility and Economic Performance.” Quarterly Journal of Economics, 105 (1990), 87114.CrossRefGoogle Scholar
Bernanke, B. S., and Gertler, M.. “Inside the Black Box: The Credit Channel of Monetary Policy Transmission.” Journal of Economic Perspectives, 9 (1995), 2748.Google Scholar
Bernanke, B. S.; Gertler, M.; and Gilchrist, S.. “The Financial Accelerator and the Flight to Quality.” Review of Economics and Statistics, 78 (1994), 115.Google Scholar
Bernanke, B. S., and Kuttner, K. N.. “What Explains the Stock Market’s Reaction to Federal Reserve Policy?Journal of Finance, 60 (2005), 12211257.CrossRefGoogle Scholar
Bernanke, B. S., and Mihov, I.. “Measuring Monetary Policy.” Quarterly Journal of Economics, 113 (1998), 869902.Google Scholar
Bjørnland, H. C., and Leitemo, K.. “Identifying the Interdependence between US Monetary Policy and the Stock Market.” Journal of Monetary Economics, 56 (2009), 275282.Google Scholar
Black, F.; Jensen, M. C.; and Scholes, M.. “The Capital Asset Pricing Model: Some Empirical Tests.” In Studies in the Theory of Capital Markets, Jensen, M., ed. New York, NY: Praeger (1972).Google Scholar
Boons, M.State Variables, Macroeconomic Activity, and the Cross-Section of Individual Stocks.” Journal of Financial Economics, 119 (2016), 489511.Google Scholar
Botshekan, M.; Kraeussl, R.; and Lucas, A.. “Cash Flow and Discount Rate Risk in Up and Down Markets: What Is Actually Priced?Journal of Financial and Quantitative Analysis, 47 (2012), 12791301.Google Scholar
Brennan, M. J.; Wang, A. W.; and Xia, Y.. “Estimation and Test of a Simple Model of Intertemporal Capital Asset Pricing.” Journal of Finance, 59 (2004), 17431775.Google Scholar
Brennan, M. J., and Xia, Y.. “Risk and Valuation under an Intertemporal Capital Asset Pricing Model.” Journal of Business, 79 (2006), 135.Google Scholar
Campbell, J. Y.Stock Returns and the Term Structure.” Journal of Financial Economics, 18 (1987), 373399.Google Scholar
Campbell, J. Y.A Variance Decomposition for Stock Returns.” Economic Journal, 101 (1991), 157179.Google Scholar
Campbell, J. Y.Understanding Risk and Return.” Journal of Political Economy, 104 (1996), 298345.Google Scholar
Campbell, J. Y.; Giglio, S.; Polk, C.; and Turley, R.. “An Intertemporal CAPM with Stochastic Volatility.” Working Paper, Harvard University (2016).Google Scholar
Campbell, J. Y., and Vuolteenaho, T.. “Bad Beta, Good Beta.” American Economic Review, 94 (2004), 12491275.CrossRefGoogle Scholar
Carhart, M. M.On Persistence in Mutual Fund Performance.” Journal of Finance, 52 (1997), 5782.CrossRefGoogle Scholar
Chen, J.“Intertemporal CAPM and the Cross-Section of Stock Returns.” Working Paper, University of California at Davis (2003).Google Scholar
Chen, S.-S.Does Monetary Policy Have Asymmetric Effects on Stock Returns?Journal of Money, Credit and Banking, 39 (2007), 667688.Google Scholar
Cochrane, J. H.A Cross-Sectional Test of an Investment-Based Asset Pricing Model.” Journal of Political Economy, 104 (1996), 572621.Google Scholar
Cochrane, J. H. Asset Pricing, rev. ed. Princeton, NJ: Princeton University Press (2005).Google Scholar
Cohen, R. B.; Polk, C.; and Vuolteenaho, T.. “The Value Spread.” Journal of Finance, 58 (2003), 609641.Google Scholar
Cooper, M. J.; Gulen, H.; and Schill, M. S.. “Asset Growth and the Cross-Section of Stock Returns.” Journal of Finance, 63 (2008), 16091651.Google Scholar
De Bondt, W. F. M., and Thaler, R. H.. “Does the Stock Market Overreact?Journal of Finance, 40 (1985), 793805.Google Scholar
De Bondt, W. F. M., and Thaler, R. H.. “Further Evidence on Investor Overreaction and Stock Market Seasonality.” Journal of Finance, 42 (1987), 557581.Google Scholar
Dechow, P. M.; Sloan, R. G.; and Soliman, M. T.. “Implied Equity Duration: A New Measure of Equity Risk.” Review of Accounting Studies, 9 (2004), 197228.Google Scholar
Fama, E. F.Does the Fed Control Interest Rates?Review of Asset Pricing Studies, 2 (2013), 180199.Google Scholar
Fama, E. F., and French, K. R.. “Dividend Yields and Expected Stock Returns.” Journal of Financial Economics, 22 (1988), 325.Google Scholar
Fama, E. F., and French, K. R.. “Business Conditions and Expected Returns on Stock and Bonds.” Journal of Financial Economics, 25 (1989), 2349.Google Scholar
Fama, E. F., and French, K. R.. “The Cross-Section of Expected Stock Returns.” Journal of Finance, 47 (1992), 427465.Google Scholar
Fama, E. F., and French, K. R.. “Common Risk Factors in the Returns on Stocks and Bonds.” Journal of Financial Economics, 33 (1993), 356.CrossRefGoogle Scholar
Fama, E. F., and French, K. R.. “Multifactor Explanations of Asset Pricing Anomalies.” Journal of Finance, 51 (1996), 5584.Google Scholar
Fama, E. F., and French, K. R.. “The Value Premium and the CAPM.” Journal of Finance, 61 (2006), 21632185.Google Scholar
Fama, E. F., and French, K. R.. “Dissecting Anomalies.” Journal of Finance, 63 (2008), 16531678.Google Scholar
Fama, E. F., and French, K. R.. “Size, Value, and Momentum in International Stock Returns.” Journal of Financial Economics, 105 (2012), 457472.Google Scholar
Fama, E. F., and French, K. R.. “A Five-Factor Asset Pricing Model.” Journal of Financial Economics, 116 (2015), 122.Google Scholar
Fama, E. F., and French, K. R.. “Dissecting Anomalies with a Five-Factor Model.” Review of Financial Studies, 29 (2016), 69103.Google Scholar
Fama, E. F., and MacBeth, J. D.. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy, 81 (1973), 607636.Google Scholar
Garret, I., and Priestley, R.. “Dividend Growth, Cash Flow, and Discount Rate News.” Journal of Financial and Quantitative Analysis, 47 (2012), 10031028.Google Scholar
Gilchrist, S., and Leahy, J. V.. “Monetary Policy and Asset Prices.” Journal of Monetary Economics, 49 (2002), 7597.Google Scholar
Gospodinov, N.; Kan, R.; and Robotti, C.. “Misspecification-Robust Inference in Linear Asset-Pricing Models with Irrelevant Risk Factors.” Review of Financial Studies, 27 (2014), 21392170.Google Scholar
Guo, H.Time-Varying Risk Premia and the Cross Section of Stock Returns.” Journal of Banking and Finance, 30 (2006), 20872107.Google Scholar
Guo, H., and Savickas, R.. “Average Idiosyncratic Volatility in G7 Countries.” Review of Financial Studies, 21 (2008), 12591296.Google Scholar
Hahn, J., and Lee, H.. “Yield Spreads as Alternative Risk Factors for Size and Book-to-Market.” Journal of Financial and Quantitative Analysis, 41 (2006), 245269.Google Scholar
Hansen, L. P., and Jagannathan, R.. “Assessing Specification Errors in Stochastic Discount Factor Models.” Journal of Finance, 52 (1997), 557590.Google Scholar
Haugen, R. A., and Baker, N. L.. “Commonality in the Determinants of Expected Stock Returns.” Journal of Financial Economics, 41 (1996), 401439.CrossRefGoogle Scholar
Hodrick, R. J.Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement.” Review of Financial Studies, 5 (1992), 357386.Google Scholar
Hodrick, R. J., and Zhang, X.. “Evaluating the Specification Errors of Asset Pricing Models.” Journal of Financial Economics, 62 (2001), 327376.Google Scholar
Hou, K.; Xue, C.; and Zhang, L.. “Digesting Anomalies: An Investment Approach.” Review of Financial Studies, 28 (2015), 650705.Google Scholar
Jagannathan, R., and Wang, Z.. “An Asymptotic Theory for Estimating Beta-Pricing Models Using Cross-Sectional Regressions.” Journal of Finance, 53 (1998), 12851309.Google Scholar
Jagannathan, R., and Wang, Y.. “Lazy Investors, Discretionary Consumption, and the Cross-Section of Stock Returns.” Journal of Finance, 62 (2007), 16231661.Google Scholar
Jegadeesh, N., and Titman, S.. “Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency.” Journal of Finance, 48 (1993), 6591.Google Scholar
Jensen, G. R.; Mercer, J. M.; and Johnson, R. R.. “Business Conditions, Monetary Policy, and Expected Security Returns.” Journal of Financial Economics, 40 (1996), 213237.Google Scholar
Kan, R.; Robotti, C.; and Shanken, J.. “Pricing Model Performance and the Two-Pass Cross-Sectional Regression Methodology.” Journal of Finance, 68 (2013), 26172649.Google Scholar
Kan, R., and Zhang, C.. “Two-Pass Tests of Asset Pricing Models with Useless Factors.” Journal of Finance, 54 (1999), 203235.Google Scholar
Keim, D. B., and Stambaugh, R. F.. “Predicting Returns in the Stock and Bond Markets.” Journal of Financial Economics, 17 (1986), 357390.Google Scholar
Kleibergen, F.Tests of Risk Premia in Linear Factor Models.” Journal of Econometrics, 149 (2009), 149173.Google Scholar
Lakonishok, J.; Shleifer, A.; and Vishny, R. W.. “Contrarian Investment, Extrapolation, and Risk.” Journal of Finance, 49 (1994), 15411578.Google Scholar
Lettau, M., and Wachter, J. A.. “Why Is Long-Horizon Equity Less Risky? A Duration-Based Explanation of the Value Premium.” Journal of Finance, 62 (2007), 5592.Google Scholar
Lewellen, J.; Nagel, S.; and Shanken, J.. “A Skeptical Appraisal of Asset-Pricing Tests.” Journal of Financial Economics, 96 (2010), 175194.Google Scholar
Lintner, J.The Valuation of Risk Assets and the Selection of Risky Investments in Stock Portfolios and Capital Budgets.” Review of Economics and Statistics, 47 (1965), 1337.Google Scholar
Lioui, A., and Maio, P.. “Interest Rate Risk and the Cross-Section of Stock Returns.” Journal of Financial and Quantitative Analysis, 49 (2014), 483511.Google Scholar
Lyandres, E.; Sun, L.; and Zhang, L.. “The New Issues Puzzle: Testing the Investment-Based Explanation.” Review of Financial Studies, 21 (2008), 28252855.Google Scholar
Maio, P.Intertemporal CAPM with Conditioning Variables.” Management Science, 59 (2013a), 122141.Google Scholar
Maio, P.Return Decomposition and the Intertemporal CAPM.” Journal of Banking and Finance, 37 (2013b), 49584972.CrossRefGoogle Scholar
Maio, P.Another Look at the Stock Return Response to Monetary Policy Actions.” Review of Finance, 18 (2014a), 321371.Google Scholar
Maio, P.Don’t Fight the Fed!Review of Finance, 18 (2014b), 623679.Google Scholar
Maio, P.“Do Traded Risk Factors Outperform Non-Traded Factors?” Working Paper, Hanken School of Economics (2017).Google Scholar
Maio, P., and Santa-Clara, P.. “Multifactor Models and Their Consistency with the ICAPM.” Journal of Financial Economics, 106 (2012), 586613.Google Scholar
Merton, R. C.An Intertemporal Capital Asset Pricing Model.” Econometrica, 41 (1973), 867887.Google Scholar
Nagel, S.Empirical Cross-Sectional Asset Pricing.” Annual Review of Financial Economics, 5 (2013), 167199.Google Scholar
Newey, W. K., and West, K. D.. “A Simple, Positive Semi-Definite, Heteroskedasticity and Autocorrelation Consistent Covariance Matrix.” Econometrica, 55 (1987), 703708.Google Scholar
Nielsen, L. T., and Vassalou, M.. “The Instantaneous Capital Market Line.” Economic Theory, 28 (2006), 651664.Google Scholar
Novy-Marx, R.The Other Side of Value: The Gross Profitability Premium.” Journal of Financial Economics, 108 (2013), 128.Google Scholar
Pástor, L., and Stambaugh, R. F.. “Liquidity Risk and Expected Stock Returns.” Journal of Political Economy, 111 (2003), 642684.Google Scholar
Patelis, A. D.Stock Return Predictability and the Role of Monetary Policy.” Journal of Finance, 52 (1997), 19511972.Google Scholar
Peek, J.; Rosengren, E. S.; and Tootell, G. M. B.. “Does the Federal Reserve Possess an Exploitable Informational Advantage?Journal of Monetary Economics, 50 (2003), 817839.Google Scholar
Petkova, R.Do the Fama–French Factors Proxy for Innovations in Predictive Variables?Journal of Finance, 61 (2006), 581612.Google Scholar
Rigobon, R., and Sack, B.. “Measuring the Reaction of Monetary Policy to the Stock Market.” Quarterly Journal of Economics, 118 (2003), 639669.Google Scholar
Rigobon, R., and Sack, B.. “The Impact of Monetary Policy on Asset Prices.” Journal of Monetary Economics, 51 (2004), 15531575.Google Scholar
Roll, R.A Critique of the Asset Pricing Theory’s Tests, Part I: On Past and Potential Testability of the Theory.” Journal of Financial Economics, 4 (1977), 129176.Google Scholar
Romer, C. D., and Romer, D. H.. “Federal Reserve Information and the Behavior of Interest Rates.” American Economic Review, 90 (2000), 429457.Google Scholar
Rosenberg, B.; Reid, K.; and Lanstein, R.. “Persuasive Evidence of Market Inefficiency.” Journal of Portfolio Management, 11 (1985), 917.Google Scholar
Shanken, J.Intertemporal Asset Pricing: An Empirical Investigation.” Journal of Econometrics, 45 (1990), 99120.Google Scholar
Shanken, J.On the Estimation of Beta Pricing Models.” Review of Financial Studies, 5 (1992), 134.Google Scholar
Sharpe, W. F.Capital Asset Prices: A Theory of Market Equilibrium under Conditions of Risk.” Journal of Finance, 19 (1964), 425442.Google Scholar
Thorbecke, W.On Stock Market Returns and Monetary Policy.” Journal of Finance, 52 (1997), 635654.Google Scholar
Titman, S.; Wei, K. C. J.; and Xie, F.. “Capital Investments and Stock Returns.” Journal of Financial and Quantitative Analysis, 39 (2004), 677700.Google Scholar
Vassalou, M.News Related to Future GDP Growth as a Risk Factor in Equity Returns.” Journal of Financial Economics, 68 (2003), 4773.Google Scholar
Xing, Y.Interpreting the Value Effect through the Q-Theory: An Empirical Investigation.” Review of Financial Studies, 21 (2008), 17671795.Google Scholar
Yogo, M.A Consumption-Based Explanation of Expected Stock Returns.” Journal of Finance, 61 (2006), 539580.Google Scholar
Supplementary material: File

Maio and Santa-Clara supplementary material

Maio and Santa-Clara supplementary material

Download Maio and Santa-Clara supplementary material(File)
File 303.8 KB