Time–Varying Dynamics and Asymmetric Effects of the Fama–French Factor Betas

Abstract

We examine the impact of information shocks on systematic equity risk in a multiple-factor linear model framework. Using nonparametric and parametric models, we test for the presence of asymmetric effects of information shocks on the Fama–French factor betas. Overall, we document that market, size and book-to-market betas display different asymmetry patterns with respect to new information. More specifically, we find that market factor betas increase (decrease) following large negative (positive) market innovations. No evidence of an asymmetric response to the news is found for the size (SMB) factor betas. The book-to-market betas seem to decrease (increase) following large negative (positive) shocks to the book-to-market (HML) portfolio. Based on dynamic estimates of our empirical Fama–French betas we derive the economic values which an investor can gain by using dynamic factor loadings in portfolio selection. Finally, using stochastic dominance principles, we compare the performance of industry hedge portfolios.

Keywords: asymmetry, economic value, Fama–French model, information shocks, systematic risk

JEL Classification: G12