A Macroeconomic Hedge Portfolios and the Cross-Section of Stock Returns

46 Pages Posted: 25 May 2016 Last revised: 27 Jan 2018

See all articles by Maximilian Renz

Maximilian Renz

Frankfurt School of Finance & Management

Olaf Stotz

Frankfurt School of Finance and Management

Date Written: October 25, 2016

Abstract

This paper proposes a zero-investment portfolio that can be used to hedge against unexpected changes in the state of the economy. The so-called “macroeconomic hedge portfolio” (MHP) is formed based on a stock's hedging ability, which we derive from a stock's price reaction to important scheduled macroeconomic news. This portfolio earns a positive risk premium over time and a similar premium when used as a risk factor in an asset pricing model. A model that includes the MHP along with the market factor can explain the cross-section of stock returns about as well as the factor models of Fama and French (1993, 2014). Furthermore, our results provide a possible risk-based explanation for the roles of the characteristic-sorted Fama-French factors: they are, to some extent, compensation for higher exposure to the risk related to unexpected changes in the state of the economy. When the MHP is present in a model, the Fama-French factors lose much of their ability to explain the cross-section of stock returns.

Keywords: Asset Pricing, Expected Returns, Scheduled Macroeconomic Announcements, Macroeconomic Hedge Portfolio, Characteristic-sorted Risk Factors

JEL Classification: G11, G12

Suggested Citation

Renz, Maximilian and Stotz, Olaf, A Macroeconomic Hedge Portfolios and the Cross-Section of Stock Returns (October 25, 2016). Available at SSRN: https://ssrn.com/abstract=2784249 or http://dx.doi.org/10.2139/ssrn.2784249

Maximilian Renz (Contact Author)

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

Olaf Stotz

Frankfurt School of Finance and Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

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