The Journal of Finance

Interpreting Factor Models

Published: 02/02/2018   |   DOI: 10.1111/jofi.12612

SERHIY KOZAK, STEFAN NAGEL, SHRIHARI SANTOSH

We argue that tests of reduced‐form factor models and horse races between “characteristics” and “covariances” cannot discriminate between alternative models of investor beliefs. Since asset returns have substantial commonality, absence of near‐arbitrage opportunities implies that the stochastic discount factor can be represented as a function of a few dominant sources of return variation. As long as some arbitrageurs are present, this conclusion applies even in an economy in which all cross‐sectional variation in expected returns is caused by sentiment. Sentiment‐investor demand results in substantial mispricing only if arbitrageurs are exposed to factor risk when taking the other side of these trades.

Equity Term Structures without Dividend Strips Data

Published: 10/24/2024   |   DOI: 10.1111/jofi.13394

STEFANO GIGLIO, BRYAN KELLY, SERHIY KOZAK

We use a large cross section of equity returns to estimate a rich affine model of equity prices, dividends, returns, and their dynamics. Our model prices dividend strips of the market and equity portfolios without using strips data in the estimation. Yet model‐implied equity yields closely match yields on traded strips. Our model extends equity term‐structure data over time (to the 1970s) and across maturities, and generates term structures for various equity portfolios. The novel cross section of term structures from our model covers 45 years and includes several recessions, providing a novel set of empirical moments to discipline asset pricing models.