Capital Share Risk and Shareholder Heterogeneity in U.S. Stock Pricing

Value and momentum strategies earn persistently large return premia yet are negatively correlated. Why? We show that a quantitatively large fraction of the negative correlation is explained by strong opposite signed exposure of value and momentum portfolios to a single aggregate risk factor based on low frequency fluctuations in the capital share. Moreover, this negatively correlated component is priced. Models with capital share risk explain up to 85% of the variation in average returns on size-book/market portfolios and up to 95% of momentum returns and the pricing errors on both sets of portfolios are lower than those of the Fama-French three- and four-factor models, the intermediary SDF model of Adrian, Etula, and Muir (2014), and models based on low frequency exposure to aggregate consumption risk. None of the betas for these factors survive in a horse race where a long-horizon capital share beta is included. We show that opposite signed exposure of value and momentum to capital share risk coincides with oppositive signed exposure to the income shares of stockholders in the top 10 versus bottom 90 percent of the stock wealth distribution. Thus, the portfolios are priced as if representative investors from different percentiles of the wealth distribution pursue different investment strategies.