Macroeconomic Risks and Characteristic-Based Factor Models
37 Pages Posted: 11 Jan 2005 Last revised: 23 Dec 2019
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Macroeconomic Risks and Characteristic-Based Factor Models
Macroeconomic Risks and Characteristic-Based Factor Models
Date Written: July 26, 2007
Abstract
We use multivariate GMM models to show that book-to-market, size, and momentum capture cross-sectional variation in exposures to a broad set of macroeconomic factors identified in the prior literature as potentially important for pricing equities. The factors considered include innovations in economic growth expectations, inflation, the aggregate survival probability, the term structure of interest rates, and the exchange rate. Factor mimicking portfolios constructed on the basis of book-to-market, size, and momentum therefore serve as proxy composite macroeconomic risk factors. Conditional and unconditional cross--sectional asset pricing tests indicate that most of the macroeconomic factors are priced. The performance of an asset pricing model based on the macroeconomic factors is comparable to the performance of the Fama and French (1993, 1992) model. However, the momentum factor is found to contain incremental information for asset pricing.
Keywords: Fama and French model, Carhart model, asset pricing, book-to-market, size, momentum, macroeconomic pricing factors
JEL Classification: G11, G12, G15
Suggested Citation: Suggested Citation
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