The "failure" of the CAPM, more precisely, its inability to account for the cross section of average stock returns, has probably remained one of the main drivers behind research in asset pricing. Since Fama and French (1993), many empirically successful asset pricing models have been proposed. However, much less has been said when it comes to providing economically founded explanations for the asset pricing anomalies detected.
What is the economic intuition behind the Fama and French (1993) factors? What risk factors can possibly explain their existence? What would candidate explanatory factors imply for standard asset pricing models? Should we rethink common defi?nitions of risk?
While aggregate macroeconomic risk is generally accepted to be the source of risk premia in asset markets, so far, theoretical asset pricing models have restricted its defi?nition to the variability of consumption. However, consumption is just one of many macroeconomic time series. Moreover, it happens to be one of the smoothest, making it not the most favorable choice, given the size of risk premia that need to be explained.
Concerning the relation of risk premia to alternative macroeoconomic aggregates, Rangvid (2006), for example, provides evidence on the relation between expected returns and output. He shows that the ratio of share price to GDP captures more of the variation over time in expected returns on the aggregate market, than do ratios of price to-earnings or price-to-dividends. Cooper and Priestley (2007) demonstrate that the output gap is a predictor of returns on stocks as well as bonds. Interestingly, there also exists a link between output and returns in the cross section: Liew and Vassalou (2000) show that the Fama and French (1993) factors forecast GDP growth.