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A new risk factor based on equity duration

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  • Mohrschladt, Hannes
  • Nolte, Sven

Abstract

We introduce a new risk factor linking a firms equity duration to investment opportunity risk. Low-duration firms generate short-run cash flows and face strong reinvestment risk. High-duration firms have long-run cash flows and their present value increases when discount rates decrease as a result of a deteriorating investment environment. Our empirical analysis reveals a significant return premium of low-duration stocks, confirming that investors charge a risk premium for stocks with returns that are positively related to the investment environment. Our newly introduced risk factor carries significant risk premiums in cross-sectional asset pricing tests. These premiums are robust to including further risk factors and a variety of different test specifications. Notably, our duration risk factor retains high explanatory power on the cross-section of stock returns in a model including direct measurement of the investment environment via state variable innovations.

Suggested Citation

  • Mohrschladt, Hannes & Nolte, Sven, 2018. "A new risk factor based on equity duration," Journal of Banking & Finance, Elsevier, vol. 96(C), pages 126-135.
    • Handle: RePEc:eee:jbfina:v:96:y:2018:i:c:p:126-135
    DOI: 10.1016/j.jbankfin.2018.09.002
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    1. Rafaela Dezidério dos Santos Rocha & Márcio Laurini, 2023. "Factor Sufficiency in Asset Pricing: An Application for the Brazilian Market," IJFS, MDPI, vol. 11(4), pages 1-31, December.

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    More about this item

    Keywords

    Duration; Multifactor models; Asset pricing; State variable innovations;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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