Essays on asset pricing anomalies

Abstract

Asset pricing anomalies refer to robust empirical patterns in asset prices and returns which are contradictory to theoretical asset pricing models. This compilation thesis comprises four empirical essays which study selected anomalies from a behavioral perspective and cover the following research topics:

The discounts on Closed-End Funds make a strong case for behavioral finance since the stylized fact that two identical cash flows have different prices is hard to reconcile with the law of one price, an important pillar of neoclassical finance. Research in psychology and decision theory suggests that investment decisions of retail investors are subject to a preference for skewness, tantamount to a higher demand for assets with lottery-like payoffs. The first essay introduces the difference between market prices and fundamental values of Closed-End Funds as a novel testing ground to quantify pricing effects of lottery demand. Skewness and economy-wide skewness preferences are a new piece towards solving the Closed-End Fund puzzle and explain variations in discounts above and beyond alternative propositions in the literature.

The positive trade-off between risk and return is a second pillar of neoclassical finance. Risk-averse investors accept higher risk only in expectation of higher returns. Empirically, however, the relationship between average returns and the two most widely adopted risk measures volatility and market beta is negative. The three remaining essays of this dissertation propose unaccounted factors as an explanation for the negative expected returns of risky stocks. Each of the three studies proposes novel approaches to quantify latent factors in the investors factor model without a conjecture about the source of unaccounted risk, thus facilitating an ex ante impartial evaluation of existing theories, e.g. short sale constraints or investor sentiment.

Although each study proposes a different technical identification strategy, thorough discrimination tests highlight that behaviorally motivated propositions attain the highest explanatory power which is not easily shared by alternative theories. Stocks with high idiosyncratic volatility and high beta are exposed to demand of sentimental investors, so-called noise traders. This unexpected buying pressure inflates prices and causes temporary spikes in volatility, followed by negative expected returns in the near future.

The results in this thesis are interesting for future research in empirical finance and investors alike. Each essay pins down adverse effects due to skewness preferences and noise trader demand in aggregate asset prices and thus helps understanding determinants of asset prices and returns.