Assessing the Use of Gold as a Zero-Beta Asset in Empirical Asset Pricing : Application to the Us Equity Market

This paper examines the use of the return on gold instead on treasury bills in empirical asset pricing models in the US equity market. Recent studies have examined the safe-haven and hedging properties of gold in developed markets, particularly during a financial crisis. The close relationship of interest rates, stock, and gold returns also has been widely documented. We extend this research by assessing the use of gold as a zero-beta asset in asset pricing, and find that a range of asset pricing models have improved performance when pricing US equities and industries between 1981 and 2015. We employ an extensive range of test assets in comparing the performance of such gold zero-beta models with traditional empirical factor models, which use the 1-month Treasury bill rate as a risk-free rate. In time-series, we obtain higher R-squared values, lower Sharpe ratios of alphas and fewer significant pricing errors when we use gold as a zero-beta asset. Additionally, the pricing of small stock portfolios is improved. In cross-section, we also find improved results, with fewer cross-sectional pricing errors and more economically meaningful pricing of risk factors. A zero-beta gold factor constructed to be orthogonal to the Carhart four factors is significant in cross-section and helps to improve factor model performance on momentum portfolios. The Fama-French three- and five- factor asset pricing models and the Carhart model are all improved by these means, particularly on test assets which have been poorly priced by the traditional versions. Our results have salient implications for policymakers, governments, and investors