Abstracts

We extend the influential framework of Campbell (1993) and Campbell and Vuolteenaho (2004) to an intertemporal CAPM where coskewness of asset returns with news about cash flows and discount rates is priced. In the model, news about future risk, defined as the variance of the SDF plus the market portfolio, is determined by the quadratics of shocks to discount rates and shocks to cash flows. Assets with good coskewness have lower expected returns as they act as hedges against increases in volatility of news to cash flows and volatility of news to discount rates. Assets with bad coskewness have higher expected returns as they are negatively correlated with simultaneous shocks to cash flow news and discount rate news, which predicts an increase in future risk. An empirical implementation of the intertemporal model captures approximately 73\% of the return variation across size/book-to-market, size/momentum, and industry portfolios. We find that the momentum strategy has significantly higher exposures to risk related to simultaneous news about discount rates and cash flows that increase future risk. We show that the price of risk for hedging against simultaneous shocks to cash flows and discount rates is economically and statistically important and a significant determinant of the momentum premium.