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Endogenous Information, Risk Characterization, and the Predictability of Average Stock Returns

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  • Pradosh Simlai

    (University of North Dakota)

Abstract

In this paper we provide a new type of risk characterization of the predictability of two widely known abnormal patterns in average stock returns: momentum and reversal. The purpose is to illustrate the relative importance of common risk factors and endogenous information. Our results demonstrates that in the presence of zero-investment factors, spreads in average momentum and reversal returns correspond to spreads in the slopes of the endogenous information. The empirical findings support the view that various classes of firms react differently to volatility risk, and endogenous information harbor important sources of potential risk loadings. Taken together, our results suggest that returns are influenced by random endogenous information flow, which is asymmetric in nature, and can be used as a performance attribution factor. If one fails to incorporate the existing asymmetric endogenous information hidden in the historical behavior, any attempt to explore average stock return predictability will be subject to an unquantified specification bias.

Suggested Citation

  • Pradosh Simlai, 2012. "Endogenous Information, Risk Characterization, and the Predictability of Average Stock Returns," Brazilian Review of Finance, Brazilian Society of Finance, vol. 10(3), pages 291-315.
    • Handle: RePEc:brf:journl:v:10:y:2012:i:3:p:291-315
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    More about this item

    Keywords

    stock returns; volatility persistence; endogenous information; momentum; reversal;
    All these keywords.

    JEL classification:

    • G1 - Financial Economics - - General Financial Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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