Published Papers

Does idiosyncratic volatility proxy for risk exposure? (with Zhanhui Chen), 2014

Review of Financial Studies 25, 2745-2787

We decompose aggregate market variance into an average correlation component and an average variance component. Only the latter commands a negative price of risk in the cross-section of portfolios sorted by idiosyncratic volatility. Portfolios with high (low) idiosyncratic volatility relative to the Fama-French model have positive (negative) exposures to innovations in average stock variance and therefore lower (higher) expected returns. These two findings explain the idiosyncratic volatility puzzle of Ang, et al. (2006, 2009). The factor related to innovations in average variance also reduces the pricing errors of book-to-market and momentum portfolios relative to the Fama-French (1993) model.

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Correlation Risk (with CNV Krishnan and Peter Ritchken), 2009

Journal of Empirical Finance 16, 353-367, Lead Article

Investors hold portfolios of assets with different risk-reward profiles for diversification benefits. Conditional on the volatility of assets, diversification benefits can vary over time depending on the correlation structure among asset returns. The correlation of returns between assets has varied substantially over time. To insure against future “low diversification” states, investors might demand securities that offer higher payouts in these states. If this is the case, then investors would pay a premium for securities that perform well in regimes in which the correlation is high. We empirically test this hypothesis and find that correlation carries a significantly negative price of risk, after controlling for asset volatility and other risk factors.

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The expected value premium (with Long Chen and Lu Zhang), 2007

Journal of Financial Economics 87, 269-280

Fama and French (2002) estimate the equity premium using dividend growth rates to measure the expected rate of capital gain. We use similar methods to study the value premium. From 1941 to 2002, the expected HML return is on average 5.1% per annum, consisting of an expected-dividend-growth component of 3.5% and an expected dividend-to-price component of 1.6%. The ex-ante HML return is also countercyclical-a positive, one-standard-deviation shock to real consumption growth rate lowers this premium by about 0.45%. Unlike the equity premium, there is only mixed evidence suggesting that the value premium has declined over time.

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Do the Fama-French factors proxy for innovations in predictive variables?, 2006

Journal of Finance 61, 581-612

The Fama-French factors HML and SMB are correlated with innovations in variables that describe investment opportunities. A model that includes shocks to the aggregate dividend yield and term spread, default spread, and one-month Treasury-bill yield explains the cross section of average returns better than the Fama-French model. When loadings on the innovations in the predictive variables are present in the model, loadings on HML and SMB lose their explanatory power for the cross section of returns. The results are consistent with an ICAPM explanation for the empirical success of the Fama-French portfolios.

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Is value riskier than growth? (with Lu Zhang), 2005

Journal of Financial Economics 78, 187-202

We study the relative risk of value and growth stocks. We find that time-varying risk goes in the right direction in explaining the value premium. Value betas tend to covary positively, and growth betas tend to covary negatively with the expected market risk premium. Our inference differs from that of previous studies because we sort betas on the expected market risk premium, instead of on the realized market excess return. However, we also find that this beta premium covariance is too small to explain the observed magnitude of the value premium within the conditional capital asset pricing model.

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