Asset-pricing research consistently produces many different explanations for the same empirical facts. As a rule of thumb, you should expect asset-pricing researchers to wildly overachieve. Behavioral researchers can typically point to several … [Continue reading]
Milton Friedman laid out his methodological approach to doing economics in his 1953 essay, The Methodology of Positive Economics. This essay gives his answer to the question: What constitutes a good economic model? Or, put differently, how would you … [Continue reading]
Stocks returns are $8\%$ per year higher than bond returns on average. It's hard to explain such a large equity premium using the standard consumption-based model because consumption growth isn't risky enough. So, to fix this problem, modern … [Continue reading]
Economists use machine learning (ML) to study asset prices in two different ways. Approach #1: use these techniques to predict the cross-section of expected returns---i.e., to predict which stocks are most likely to have high or low future returns. … [Continue reading]
In standard cross-sectional asset-pricing models, expected returns are governed by exposure to aggregate risk factors in a market populated by fully rational investors. Here's how these models work. Because investors are fully rational, they … [Continue reading]