Interest-Rate Risk Factor and Stock Returns: A Time-Varying Factor-Loadings Model

31 Pages Posted: 8 Jan 2018 Last revised: 3 May 2018

See all articles by Peng Huang

Peng Huang

Arkansas Tech University

C. James Hueng

Western Michigan University - Department of Economics

Date Written: January 3, 2009

Abstract

We extend the Fama–French three-factor model to include a risk factor that proxies for interest-rate risk faced by firms in an attempt to reduce the pricing errors that the three-factor model cannot explain. These pricing errors are observed especially in small size and low book-to-market ratio firms, which are in general more sensitive to interest-rate risk. In addition, the factor loadings are modelled as time-varying so that the investors’ learning process can be taken into account. The results show that our Time-Varying-Loadings Four-Factor (TVL4) model significantly reduces the pricing errors.

Suggested Citation

Huang, Peng and Hueng, C. James, Interest-Rate Risk Factor and Stock Returns: A Time-Varying Factor-Loadings Model (January 3, 2009). Applied Financial Economics, Vol. 19, No. 2, 2009, Available at SSRN: https://ssrn.com/abstract=3096164 or http://dx.doi.org/10.2139/ssrn.3096164

Peng Huang (Contact Author)

Arkansas Tech University ( email )

106 west o st
Russellville, AR 72801
United States

C. James Hueng

Western Michigan University - Department of Economics ( email )

Kalamazoo, MI 49008
United States

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