Factor Covariances Predict Factor Returns

47 Pages Posted: 22 Jun 2013

See all articles by Nigel J. Barradale

Nigel J. Barradale

Barradale Asset Management

Soeren Hvidkjaer

Copenhagen Business School

Date Written: June 21, 2013

Abstract

We examine low-turnover zero-investment "factor" portfolios constructed from various stock characteristics previously shown to predict returns. The nine different factor portfolios all exhibit negative market betas. Our central result is that a more negative beta across factors predicts higher factor returns over the next two years. Similarly, the average relative volatility of the factor returns, as well as the cross-sectional variance of the betas and volatilities, predicts future factor returns. While the results are difficult to reconcile with standard risk-based explanations, they are consistent with the existence of a time-varying mass of naive investors, whose trading affects the returns to characteristics-based factor portfolios. Indeed, the average beta across factors is highly negatively correlated across time with the Baker and Wurgler (2006) investor sentiment measure.

Keywords: Factor Returns, Factor Covariances, Investor Sentiment, Time-Series Predictability

JEL Classification: G12, G02

Suggested Citation

Barradale, Nigel J. and Hvidkjaer, Soeren, Factor Covariances Predict Factor Returns (June 21, 2013). Available at SSRN: https://ssrn.com/abstract=2283084 or http://dx.doi.org/10.2139/ssrn.2283084

Nigel J. Barradale (Contact Author)

Barradale Asset Management ( email )

United States

Soeren Hvidkjaer

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

HOME PAGE: http://www.hvidkjaer.net

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