Motivated from Fama’s (1991) conjecture of an explicit link between the cross-sectional and time-series stock return predictability, we investigate whether the investment factor constructed from the cross-section of stocks also has time-series predictive power for stock returns within Merton’s (1973) ICAPM framework. The evidence from both US and other G-7 countries (except Japan) suggests that the investment factor is a proxy for time-varying investment opportunities. We also find that the risk-return relation is positive and statistically significant after controlling for the covariance between the market factor and the investment factor.

Abstract We study the effect of an asset’s volatility on the expected returns of European options on the asset. Deriving predictions from a stochastic discount factor model, we show that the effect depends on whether variations in the asset’s volatility are driven by systematic or idiosyncratic volatility. While idiosyncratic-volatility-induced variations only affect the option elasticity, systematic-volatility-induced variations also oppositely affect the expected return of the asset. Since the expected asset return (elasticity) effect dominates for options with more linear (non-linear) payoffs, systematic volatility prices sufficiently in-the-money (out-of-the-money) options with the opposite (same) sign as idiosyncratic volatility. Using single-stock calls as test assets, double-sorted portfolios and Fama–MacBeth (1973) regressions broadly support the model’s predictions.

This paper investigates the information content of aggregate hedge fund flow and its predictive power with respect to bond yields. Using a sample of 9725 hedge funds from 1994 to 2012, we find that fund flow is negatively related to the changes in 10-year Treasury and Moody’s Baa bond yields one month ahead. This relation is still pronounced after controlling for other determinants of yield changes, including the amount of arbitrage capital available in the economy, suggesting a non-trivial effect of flow-induced hedge fund trading on bond yields. Flow impact on corporate bonds is further amplified during periods of decreasing market liquidity, consistent with a fire-sale hypothesis. Hedge fund flow also predicts convergence between constant maturity swap rate and constant maturity Treasury rate, as well as between the TIPS and Treasury bond yields, suggesting that hedge funds exploit arbitrage opportunities in these fixed-income markets.