Three essays on asset pricing studies

Abstract

Traditional consumption-based asset pricing models generally treat the aggregate stock market as a claim to aggregate consumption. However, according to empirical evidence, the majority of households consume primary out of wages and live with no capital gains from risky investments, this implies potential omitted stock market systematic risk sources beyond aggregate consumption. Therefore, this thesis contributes to investigating alternative pricing instruments other than aggregate consumption growth to capture omitted stock market systematic risks in the traditional consumption-based capital asset pricing model (CAPM). This thesis constructs three asset pricing models for wealth redistribution risks, asset pricing effects of heterogeneous beliefs among wealth classes, and financial stress risks. A new market systematic risk dimension is uncovered in each model and then tested using U.S. stock market data. This thesis firstly incorporates the elevated stockholder consumption volatility into the long-run risk framework to account for wealth redistribution risks. The capital variability factor (CRV) is developed to capture the accumulated short-run volatility effects of wealth redistributive shocks. Secondly, this thesis derives the analytical solution of stockholder consumption growth to account for stockholder consumption risks using a robustness control approach. The stockholder consumption share factor (SCS) is constructed to portray the stockholder consumption dynamics and affords high asset pricing. Finally, this thesis utilises the long-run risk framework to factor in that financial stress contributes to the convexity of the price-dividend ratio and, therefore, serves systematic risks. The financial stress factor (FS) is developed to explain the cross-sectional return variations of stocks with highly subjective valuations and are difficult to arbitrage. This thesis contributes to the field in multiple dimensions. This thesis attempts to introduce economic variables into data-driven models, therefore shedding light on the impact of limited participation of households in the stock market for future research. Also, new market systematic risks are uncovered and counterpart asset pricing factors are constructed. These findings are important to policymakers as financial systems are especially vulnerable to systemic risk that cannot be hedged.