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Production-Based Asset Pricing in a Monetary Economy: Theory and Evidence

Authors : Abraham Lioui
Professor of Finance, EDHEC Risk and Asset Management Research Centre

Patrice Poncet
Professor of Finance, ESSEC Business School, France.

This paper develops a capital asset pricing model based on the production side of a monetary economy.

Relying on a general version of the standard Real Business Cycle model with cash and credit goods, we find that the factors determining the mean excess returns on financial assets are i) real capital growth, ii) the nominal interest rate and iii) the capital-to-wealth ratio. Our model is parsimonious in that the results rely neither on any particular specification of the production function nor on capital adjustment costs. Empirical evidence gives strong support to the presence of the elicited factors in the cross section of excess returns on portfolios sorted i) by firm characteristics and ii) by industry. Both unconditional and conditional versions of the model are shown to perform as well as the Fama-French (1993) three-factor model when the universe of 25 portfolios sorted by size and book-to-market ratio is considered. In an extended universe in which 17 industry portfolios are added to these 25 portfolios, the same result holds.
Type :
Working Paper
Dates :
Created on July 1, 2008
Further information :
For more information, please contact Joanne Finlay, EDHEC Research and Development Department [ joanne.finlay@edhec.edu ]

The contents of this paper do not necessarily reflect the opinions of EDHEC Business School.

Finance


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