Deriving Characteristic-Based Returns from Market-Clearing Equilibrium

Summary

The document develops a model for how firm characteristics can shape asset returns in equilibrium. It assumes investors' demands depend separately on firm characteristics and asset log-prices, while asset supply is exogenous and not driven by factors. With demands that are linear in characteristics, market clearing produces returns that can also depend linearly on those characteristics. The resulting coefficients represent scaled aggregate net demand and changes in that demand, and the authors describe estimating them jointly with panel regressions.

The analysis derives conditions that connect asset-pricing anomalies to relationships among characteristics. In the reported empirical results, when the set of characteristics is small, firm-specific fixed effects account for much of the value and momentum anomalies. The authors interpret these effects as latent investor demands and argue that low-dimensional models can miss important structure. The document does not specify the dataset, regression details, or robustness tests, so the empirical claims cannot be evaluated further from this account. The equilibrium result also depends on its assumptions about investor demand and asset supply.

Key ideas

• Separate dependence of investor demand on characteristics and log-prices supports the equilibrium derivation.
• Linear characteristic-based demands and exogenous supply yield returns related linearly to characteristics.
• The model's coefficients represent scaled aggregate demand and changes in demand.
• The authors estimate those coefficients jointly with panel regressions.
• With few characteristics, firm-specific fixed effects reportedly explain much of the value and momentum anomalies.

Tags

# Characteristics-driven returns in equilibrium


# Characteristics-driven returns in equilibrium









We reverse-engineer the equilibrium construction process of asset prices in order to obtain returns which depend on firm characteristics, possibly in a linear fashion. One key requirement is that agents must have demands that rely separately on firm characteristics and on the log-price of assets. Market clearing via exogenous (non-factor driven) supply, combined with linear demands in characteristics, yields the sought form. The coefficients in the resulting linear expressions are scaled net aggregate demands for characteristics, as well as their variations, and both can be jointly estimated via panel regressions. Conditions underpinning asset pricing anomalies are derived and underline the theoretical importance of the links between characteristics. Empirically, when the number of characteristics is small, the value and momentum anomalies are mostly driven by firm-specific fixed-effects, i.e., latent demands, which highlights the shortcomings of low-dimensional models.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.