NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Cash-Flow Risk, Discount Risk, and the Value Premium

Tano Santos, Pietro Veronesi

NBER Working Paper No. 11816
Issued in December 2005
NBER Program(s):   AP

A habit persistence, general equilibrium model with multiple assets matches both the time series properties of the market portfolio and the cross-sectional predictability of returns on price sorted portfolios, the value premium. Consistent with empirical evidence, the model shows that (a) value stocks are those with higher cash-flow risk; (b) the size of the value premium is larger in “bad times,” due to time variation in risk preferences; (c) the unconditional CAPM fails, because of general equilibrium restrictions on the market portfolio. The dynamic nature of the value premium rationalizes why the conditional CAPM and a Fama and French (1993) HML factor outperform the unconditional CAPM.

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Document Object Identifier (DOI): 10.3386/w11816

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