Essays on financial economics

The first essay finds that the market betas of value and small stocks have decreased by about 75% in the second half of the twentieth century. The decline in beta can be related to a long-term improvement in economic conditions that made these companies less risky. The failure to account for time-series variation of beta in unconditional CAPM regressions can explain as much as 30% of the value premium. In some samples, about 80% of the value premium can be explained by assuming that investors tied their expectations of the riskiness of these stocks to the high values of beta prevailing in the early years. Moving from these findings, the second essay (co-authored with Tobias Adrian) explores in detail the relation between the 'value premium' and the decrease in value stocks' beta. We develop an equilibrium model of learning on time-varying risk factor loadings. In the model the CAPM holds from investors' ex-ante perspective. However, the econometrician can observe positive mispricing, whenever the expected beta is above the true level. Given the finding of a decreasing beta, it is likely that investors' expectation of the beta of these stocks has been above the actual level. Therefore, our model can provide an explanation for the 'value premium'. We present the results of simulations in which the model accounts for up to 80% of the 'value premium' in the 1963-2000 sample.

Department dc:contributor.department

Massachusetts Institute of Technology. Dept. of Economics.

Grantor dc:publisher

Massachusetts Institute of Technology

Year dc:date.issued

2002

Author dc:creator

• Franzoni, Francesco, 1972-

Advisor dc:contributor.advisor

• Sendhil Mullainathan and Jonathan Lewellen.

• Economics.

Statement dc:rights

• M.I.T. theses are protected by copyright. They may be viewed from this source for any purpose, but reproduction or distribution in any format is prohibited without written permission. See provided URL for inquiries about permission.

Licence dc:rights.uri

• http://dspace.mit.edu/handle/1721.1/7582

Language dc:language.iso

eng

Handle dc:identifier.uri

http://hdl.handle.net/1721.1/29926

OAI identifier oai:identifier

oai:dspace.mit.edu:1721.1/29926