Market Risk Factors
Sunday, Jan. 6, 2019 8:00 AM - 10:00 AM
- Chair: Jianfeng Yu, Tsinghua University
Hedging Risk Factors
AbstractStandard risk factors can be hedged with minimal reduction in average return. This is true for "macro" factors such as industrial production, unemployment, and credit spreads, as well as for "reduced form" asset pricing factors such as value, momentum, or profitability. Low beta versions of the factors perform close to as well as high beta versions, hence a long short portfolio can hedge factor exposure with little reduction in expected return. For the reduced form factors this mismatch between factor exposure and expected return generates large alphas. For the macroeconomic factors, hedging the factors also hedges business cycle risk by significantly lowering exposure to consumption, GDP, and NBER recessions. We study implications both for optimal portfolio formation and for understanding the economic mechanisms for generating equity risk premiums.
Are Cross-Sectional Predictors Good Market-Level Predictors?
AbstractFirm-level variables that predict cross-sectional stock returns, such as price-to-earnings and book-to-market, are often aggregated and used to predict time-series market returns. We extend this literature and limit the data-snooping bias by using a near-complete population of the literature’s cross-sectional return predictors. Our tests reject the null of no predictability at the annual horizon in-sample. Moreover, we find the literature has ignored several cross-sectional variables–such as change in asset turnover and co-skewness–that contain strong in-sample predictability. When we consider out-of-sample testing, however, we find little evidence that cross-sectional predictors make good market-level predictors.
Size and Value in China
AbstractWe construct size and value factors in China. The size factor excludes the smallest 30% of firms, which are companies valued significantly as potential shells in reverse mergers that circumvent tight IPO constraints. The value factor is based on the earnings-price ratio, which subsumes the book-to-market ratio in capturing all Chinese value effects. Our three-factor model strongly dominates a model formed by just replicating the Fama and French (1993) procedure in China. Unlike that model, which leaves a 17% annual alpha on the earnings-price factor, our model explains most reported Chinese anomalies, including profitability and volatility anomalies.
- G1 - General Financial Markets