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Can An ‘Estimation Factor’ Help Explain Cross‐Sectional Returns?

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  • Frederik Lundtofte

Abstract

We show in a theoretical model that the expected excess return on any asset depends on its covariance not only with the market portfolio, but also with changes in the representative agent's estimate. We test our model using GMM and compare it to the CAPM. The results suggest that adding an ‘estimation factor’ to the CAPM helps explain cross‐sectional returns and that, unconditionally, this estimation factor carries a negative risk premium.

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  • Frederik Lundtofte, 2009. "Can An ‘Estimation Factor’ Help Explain Cross‐Sectional Returns?," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 36(5‐6), pages 705-724, June.
    • Handle: RePEc:bla:jbfnac:v:36:y:2009:i:5-6:p:705-724
    DOI: 10.1111/j.1468-5957.2009.02131.x
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