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Essays in empirical asset pricing

Li Gu, 2006
Faculty Advisor: Andrew Ang
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The first chapter of this dissertation investigates asymmetric risk loadings in the cross section of stock returns. Time-varying factor loadings exhibit pronounced asymmetry in the cross section of stock returns. To capture this asymmetry, we develop regime-switching versions of the CAPM and the Fama French three-factor model, allowing both factor loadings and predictable risk premiums to switch across regimes. We estimate the models jointly on the decile book-to-market portfolios, together with the market portfolio to investigate the role of asymmetric risk in the book-to-market premium. We find that the betas of value stocks increase significantly during bear market episodes. However, even in the presence of regimes we still reject that the book-to-market premium is equal to zero for both the regime-switching conditional CAPM and the Fama-French model.

The second chapter, joint with Andrew Ang and Yael Hochberg, empirically examines whether the underperformance of IPOs in the post-1970 sample is a small sample effect or 'Peso' problem. That is, IPO underperformance may result from observing too few star performers ex-post than were expected ex-ante. We develop a model of IPO performance that captures this intuition by allowing returns to be drawn from mixtures of outstanding, benchmark, or poor performing states. We estimate the model under the null of no ex-ante average IPO underperformance and construct small sample distributions of various statistics measuring IPO relative performance. We find that small sample biases are extremely unlikely to account for the magnitude of the post-1970 IPO underperformance observed in data.

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