TY  - JOUR
AU  - Lin,Xiaoji
AU  - Zhang,Lu
TI  - Covariances versus Characteristics in General Equilibrium
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 17285
PY  - 2011
Y2  - August 2011
UR  - http://www.nber.org/papers/w17285
L1  - http://www.nber.org/papers/w17285.pdf
N1  - Author contact info:
Xiaoji Lin
Department of Finance
Ohio State University
2100 Neil Ave, Columbus, OH, 43210
Tel: 614-292-4318
Fax: 614-292-7062
Tel: 44-020-7852-3717
Fax: 44-020-7955-7420
E-Mail: lin_1376@fisher.osu.edu

Lu Zhang
Fisher College of Business
The Ohio State University
2100 Neil Avenue
Columbus, OH 43210
Tel: 585-267-6250
E-Mail: zhanglu@fisher.osu.edu
AB  - We question a deep-ingrained doctrine in asset pricing: If an empirical characteristic-return relation is consistent with investor "rationality," the relation must be "explained" by a risk factor model. The investment approach changes the big picture of asset pricing. Factors formed on characteristics are not necessarily risk factors: Characteristics-based factor models are linear approximations of firm-level investment returns. The evidence that characteristics dominate covariances in horse races does not necessarily mean mispricing: Measurement errors in covariances are more likely to blame. Most important, the investment approach completes the consumption approach in general equilibrium, especially for cross-sectional asset pricing.
ER  -