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Short-Term Interest Rates and Stock Market Anomalies

Published online by Cambridge University Press:  15 June 2017

Paulo Maio  and
Pedro Santa-Clara
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Abstract

We present a simple 2-factor model that helps explain several capital asset pricing model (CAPM) anomalies (value premium, return reversal, equity duration, asset growth, and inventory growth). The model is consistent with Merton’s intertemporal CAPM (ICAPM) framework, and the key risk factor is the innovation on a short-term interest rate, the federal funds rate, or the T-bill rate. This model explains a large fraction of the dispersion in the average returns of the joint market anomalies. Moreover, the model compares favorably with alternative multifactor models widely used in the literature. Hence, short-term interest rates seem to be relevant for explaining several dimensions of cross-sectional equity risk premia.

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Type
Research Article
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Journal of Financial and Quantitative Analysis , Volume 52 , Issue 3 , June 2017 , pp. 927 - 961
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2017 

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Footnotes

1

We thank Francisco Barillas (the referee), Hendrik Bessembinder (the editor), and seminar participants at the 2012 Arne Ryde workshop, the 2012 Finance Down Under Conference, the 2012 Rothschild Caesarea Center Conference, and the 2012 Annual Conference of the Swiss Society for Financial Market Research (SGF) for helpful comments on earlier drafts. We are grateful to Kenneth French, Amit Goyal, Robert Shiller, Robert Stambaugh, and Lu Zhang for making stock market data available. A previous version was titled “The Fed and Stock Market Anomalies.” Maio acknowledges financial support from the Hanken Foundation. Any remaining errors are our own.

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