IFin Seminar, Pedro Bordalo - Saïd Business School, University of Oxford - "Finance without exotic risk"
Institute of Finance
Date: 7 November 2024 / 12:25 - 13:40
Speaker: Pedro Bordalo - Saïd Business School, University of Oxford
Title: “Finance without exotic risk”
Date: November 7, 2024
Ore: 12:25 - 13:40
Room: Red Room (Executive Center)
Lugano West Campus
Abstract
We address the joint hypothesis problem in cross-sectional asset pricing by using measured analyst expectations of earnings growth. We construct a firm-level measure of Expectations Based Returns (EBRs) that uses analyst forecast errors and revisions and shuts down any cross-sectional differences in required returns. We obtain three results. First, variation in EBRs accounts for a large chunk of cross-sectional return spreads in value, investment, size, and momentum factors. Second, time variation in these spreads is predictable, and proxied by predictable time variation in EBRs. This result holds even controlling for scaled price variables, which may capture time varying required return differentials. Third, firm characteristics typically viewed as capturing risk predict disappointment of expectations (and of EBRs). Overall, return spreads typically attributed to exotic risk factors are explained by predictable movements in non-rational expectations of firms’ earnings growth.
