The NBER's Program on Asset Pricing met at the University of Chicago on March 1. Organizers John H. Cochrane and Jesus Santos, both of NBER and University of Chicago, chose these papers for discussion:
Andrew Ang, NBER and Columbia University, Joseph Chen, University of Southern California, and Yuhang Xing, Columbia University, "Downside Risk and the Momentum Effect"
Discussant: Tobias J. Moskowitz, NBER and University of Chicago
David S. Bates, NBER and University of Iowa, "The Market for Crash Risk" (NBER Working Paper No. 8557)
Discussant: Francis Longstaff, NBER and University of California, Los Angeles
Jun Liu, University of California, Los Angeles, and Jun Pan, MIT, "Dynamic Derivative Strategies"
Discussant: Michael W. Brandt, NBER and University of Pennsylvania
Michael J. Brennan and Ashley W. Wang, University of California, Los Angeles, and Yihong Xia, University of Pennsylvania, "A Simple Model of Intertemporal Capital Asset Pricing and Its Implications for the Fama-French Three-Factor Model"
Discussant: George M. Constantinides, NBER and University of Chicago
Harry Mamaysky, Yale University, "On the Joint Pricing of Stocks and Bonds: Theory and Evidence"
Discussant: Monika Piazzesi, NBER and University of California, Los Angeles
Randolph B. Cohen, Harvard University, Christopher Polk, Northwestern University, and Tuomo Vuolteenaho, NBER and Harward University, "Does Risk or Mispricing Explain the Cross-Section of Stock Prices?"
Discussant: Kent D. Daniel, NBER and Northwestern University
Stocks with greater downside risk, which is measured by higher correlations conditional on downside moves of the market, have higher returns. After controlling for the market beta, the size effect, and the book-to-market effect, the average rate of return on stocks with the greatest downside risk exceeds the average rate of return on stocks with the least downside risk by 6.55 percent per year. Downside risk is important for explaining the cross-section of expected returns. In particular, Ang, Chen, and Xing find that some of the profitability of investing in momentum strategies can be explained as compensation for bearing high exposure to downside risk.
Bates examines the equilibrium in which negative stock market jumps (crashes) can occur, and investors have heterogeneous attitudes towards crash risk. The less crash-averse insure the more crash-averse through the options markets that dynamically complete the economy. Bates compares the resulting equilibrium with various option pricing anomalies reported in the literature: the tendency of stock index options to overpredict volatility and jump risk; the Jackwerth (2000) implicit pricing kernel puzzle; and the stochastic evolution of option prices. The specification of crash aversion is compatible with the static option pricing puzzles, while heterogeneity partially explains the dynamic puzzles. Heterogeneity also substantially magnifies the stock market impact of adverse news about fundamentals.
Liu and Pan study the optimal Investment strategy of an investor who can access not only the bond and the stock markets, but also the derivatives market. …