We examine the impact of risk-based portfolio constraints on asset prices in an exchange economy. We show that constrained agents scale down their portfolio and behave locally like power utility investors with risk aversion that depends on current market conditions. In contrast to previous results in the literature, we show that the imposition of constraints dampens fundamental shocks, challeng...

This paper investigates the performance of hedge funds adjusted for higher order risk factors. Traditional risk-adjusted performance measures are subject to size distorted in the presence of skewness and kurtosis. A residual augmented least squares approach to model higher order risk moments in returns allows us to estimate a robust risk-adjusted performance measure for hedge funds. In a compar...

We study an equilibrium in which agents face surprise liquidity shocks and invest in liquid and illiquid riskless assets. The random holding horizon from liquidity shocks makes the return of the illiquid security risky. The equilibrium premium for such risk depends on the constraint that agents face when borrowing against future income; it is insignificant without borrowing constraint, but can ...

This paper examines return predictability when the investor is uncertain about the right state variables. A novel feature of the model averaging approach used in this paper is to account for finite-sample bias of the coefficients in the predictive regressions. Drawing on an extensive international dataset, we find that interest-rate related variables are usually among the most prominent predict...

I develop an analytical general-equilibrium model to explain economic sources of businesscycle pattern of aggregate stock market returns. With concave production functions and capital accumulation, a technology shock has a pro-cyclical direct effect and a counter-cyclical indirect effect on expected returns. The indirect effect, reflecting the “feedback” effect of consumers’ behavior on asset r...

This study estimates liquidity premiums using the recently developed Liu (2006) measure within a multifactor capital asset pricing model (CAPM) including size premiums and a time varying parameter model for the West African emerging market of Nigeria. The evidence suggests that liquidity factors are relevant only for financial and basic materials sector stocks while size factor is more generall...

Evidence indicates that people fear change and the unknown. We model this behavior as familiarity bias in which individuals focus on adverse scenarios in evaluating defections from the status quo. The model explains portfolio underdiversification, home and local biases. More importantly, equilibrium stock prices reflect an unfamiliarity premium. In an international setting, our model predicts t...

Portfolio optimization inputs differ widely from their subsequent out-of-sample (OOS) values. As a result, optimized portfolios have 2 to 28 times more risk OOS than their ex-ante estimates suggest. I propose a simple solution to this problem: let the data speak for itself and pick, in real time, the correction that most reduces past OOS errors. The resulting optimized portfolios consistently o...

We develop a tractable model of realization utility that studies the role of referencedependent S-shaped preferences in a dynamic investment setting with reinvestment. Our model generates both voluntarily realized gains and losses. It makes specific predictions about the volume of gains and losses, the holding periods, and the sizes of both realized and paper gains and losses that can be calibr...