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Micro Uncertainty and Asset Prices Analysis

Last Updated on 10 February, 2024 by Rejaul Karim

In the intricate web of asset pricing, “Micro Uncertainty and Asset Prices” by Bernard Herskovic, Thilo Kind, and Howard Kung offers a thought-provoking exploration into the interplay of size, value premia, and equity premiums.

This 52-page research, first penned on May 1, 2018, unravels the profound confluence and contrary movements of size and value premia with the overarching equity premium, illuminating an investment-based asset pricing model imbued with enduring micro and macro uncertainty.

Delving into the recurring waves of size and value premia, propelled by persistent micro uncertainty, and the ripple effects of macroeconomic uncertainty on equity premiums, the authors elucidate the inscrutable negative correlation between micro and macro uncertainty, underscoring the equity premium’s role as a long-term hedge for size and value premia.

Within this enthralling exposé, the study also discerns the destabilizing impact of persistent micro uncertainty on size and value factors in brief sample durations, thereby contributing a compelling perspective to the production-based asset pricing paradigm and the mosaic of cross-sectional returns.

Abstract Of Paper

Size and value premia comove strongly with one another at low frequencies, but they are both negatively related to long-run movements in the equity premium. We explain these patterns in an investment-based asset pricing model featuring persistent micro and macro uncertainty. Micro uncertainty generates size and value premia waves, while macroeconomic uncertainty produces equity premium waves. The negative correlation between micro and macro uncertainty at low frequencies explains why the equity premium is a long-term hedge for size and value premia. Persistent micro uncertainty is also a source of instability for size and value factors in short samples.

Original paper – Download PDF

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Author

Bernard Herskovic
University of California, Los Angeles (UCLA) – Anderson School of Management; National Bureau of Economic Research (NBER)

Thilo Kind
London Business School

Howard Kung
London Business School; Centre for Economic Policy Research (CEPR)

Conclusion

In the compelling denouement of “Micro Uncertainty and Asset Prices,” Bernard Herskovic, Thilo Kind, and Howard Kung deliver a resounding synthesis of the complex interplay between size and value premia, and the overarching equity premium.

Their investment-based asset pricing model, underpinning persistent micro and macro uncertainty, has unveiled profound insights into the recurring undulations of size and value premia waves fueled by micro uncertainty, juxtaposed against the influences of macroeconomic uncertainty on equity premium waves.

The discernment of a negative correlation between micro and macro uncertainty at low frequencies, elucidating the equity premium’s role as a long-term hedge for size and value premia, stands as a pivotal revelation, enriching the understanding of long-run risks and cross-sectional returns.

Additionally, the authors’ discernment of persistent micro uncertainty as a destabilizing force for size and value factors in brief sample durations offers a nuanced perspective within the production-based asset pricing paradigm.

In the final analysis, this research extends a valuable, multi-faceted contribution to the intricate domain of asset pricing and the entwined dynamics of micro and macro uncertainty.

Related Reading:

The Size Premium As a Lottery

Industry Long-Term Return Reversal

FAQ

What is the main focus of the paper “Micro Uncertainty and Asset Prices” by Bernard Herskovic, Thilo Kind, and Howard Kung?

The main focus of the paper is to explore the interplay of size, value premia, and equity premiums in the context of micro and macro uncertainty. The authors delve into the confluence and contrary movements of size and value premia with the equity premium, offering insights into the dynamics of cross-sectional returns.

What key insights does the paper provide regarding the relationship between size and value premia and the equity premium?

The paper highlights that size and value premia comove strongly with each other at low frequencies. However, both size and value premia are negatively related to long-run movements in the equity premium. The authors explain these patterns within an investment-based asset pricing model that incorporates persistent micro and macro uncertainty. The negative correlation between micro and macro uncertainty at low frequencies is identified as a key factor explaining why the equity premium serves as a long-term hedge for size and value premia.

What is the role of micro and macro uncertainty in the proposed asset pricing model?

The asset pricing model in the paper features persistent micro and macro uncertainty. Micro uncertainty generates waves in size and value premia, while macroeconomic uncertainty produces waves in the equity premium. The paper emphasizes the importance of these uncertainties in understanding the observed patterns in the comovements of size, value, and equity premia.

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