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Macroeconomic Factors Strike Back: A Bayesian Change-Point Model of Time-Varying Risk Exposures and Premia in the U.S. Cross-Section

44 Pages Posted: 12 Nov 2013 Last revised: 11 Jun 2015

Daniele Bianchi

University of Warwick, Warwick Business School

Massimo Guidolin

Bocconi University - Department of Finance

Francesco Ravazzolo

Free University of Bolzano

Date Written: June 18, 2014

Abstract

This paper proposes a Bayesian estimation framework for a typical multi-factor model with time-varying risk exposures to macroeconomic risk factors and corresponding premia to price U.S. stocks and bonds. The model assumes that risk exposures and idiosyncratic volatility follow a break-point latent process, allowing for changes at any point in time but not restricting them to change at all points. An empirical application to 40 years of U.S. data and 23 portfolios shows that the approach yields sensible results compared to previous two-step methods based on naive recursive estimation schemes, as well as a set of alternative model restrictions. A variance decomposition test shows that although most of the predictable variation comes from the market risk premium, a number of additional macroeconomic risks, including real output and inflation shocks, are significantly priced in the cross-section. A Bayes factor analysis decisively favors the proposed change-point model.

Keywords: Structural breaks, Change-point model, Stochastic volatility, Multi-factor linear models, Asset pricing

JEL Classification: G11, C53

Suggested Citation

Bianchi, Daniele and Guidolin, Massimo and Ravazzolo, Francesco, Macroeconomic Factors Strike Back: A Bayesian Change-Point Model of Time-Varying Risk Exposures and Premia in the U.S. Cross-Section (June 18, 2014). Journal of Business & Economic Statistics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2353011 or http://dx.doi.org/10.2139/ssrn.2353011

Daniele Bianchi

University of Warwick, Warwick Business School ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

HOME PAGE: http://whitesphd.com/

Massimo Guidolin

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Francesco Ravazzolo (Contact Author)

Free University of Bolzano ( email )

Bolzano
Italy

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