FEM Seminar: Raman Uppal
FINANCIAL ECONOMETRICS MACROECONOMICS
Raman Uppal, EDHEC Business School
Title: “What is Missing in Asset-Pricing Factor Models?” (joint work with Massimo Dello Preite, Paolo Zaffaroni and Irina Zviadadze)
Abstract: Our objective is to develop a methodology to price the cross section of asset returns. Despite the hundreds of systematic risk factors considered in the literature (“factor zoo"), there is still a sizable pricing error. We show that what is missing in assetpricing factor models is not systematic risk factors but compensation for asset-specific risk. We use this insight to construct a stochastic discount factor (SDF) that prices the cross section of stock returns exactly, and therefore, resolves the factor zoo. Empirically, we demonstrate that more than half of the variation in this SDF is explained by an aggregate measure of asset-specific risk that is correlated with strategies reflecting market frictions and behavioral biases.