Essays on macroeconomic risk and the financial market anomalies

Abstract

My dissertation aims at understanding the relationship between macroeconomic risk and the financial market anomalies. The first essay examines the equilibrium relation between future labor income growth and expected asset returns; it proposes revisions in the expectation of future labor income growth as a macroeconomic state variable and suggests a three-factor model, including a factor related to this variable, along with the consumption growth factor and the market factor. The proposed future labor income growth factor is positively associated with the Fama-French factors and subsumes their explanatory power in explaining the cross section of stock returns. These results provide a possible economic explanation for the roles of the Fama-French factors: they are compensation for higher exposure to the risk related to changes in the value of human capital. This essay also compares the performance of the proposed three-factor model with other competing models and finds that the proposed model specification better captures cross-sectional variation in average returns than any of the competing asset pricing models considered. The second essay examines whether momentum profits and macroeconomic risk are related. I find that momentum strategy generates economically large negative profits in bad economic states, while positive profits in good economic states, when I define states of nature based on the expected market risk premium, instead of on the realized market excess return. My findings suggest that time variation in momentum strategy is linked to variations in macroeconomic risk. Thus, these results are consistent with risk-based explanations of momentum. The third essay studies the profitability of momentum trading using a consumption-based intertemporal asset pricing model where the risk factors are news about future long-run consumption growth as well as current consumption growth. I show that long-run consumption risk goes in the right direction in e...