Asset Pricing Anomalies: Two Hedge Factors with Negative Risk Premia Embedded in Portfolios!

38 Pages Posted: 16 Jan 2017

See all articles by Arun Muralidhar

Arun Muralidhar

AlphaEngine Global Investment Solutions; George Washington University

Robert Savickas

George Washington University - School of Business - Department of Finance

Tzu-Jui Mao

International Finance Corporations (IFC)

Date Written: January 14, 2017

Abstract

The primary purpose of this research is to empirically test a new asset pricing model, the Relative Asset Pricing Model (RAPM), and to confirm whether hedge portfolios on two new risk factors highlighted in that model, and embedded in all portfolios, have negative and significant risk premia. In a number of specifications, this first test of RAPM appears to validate the importance of these two ubiquitous risk factors: (i) a liability proxy or Strategic Asset Allocation (SAA); and (ii) an index of traditional rebalancing back to the SAA (REBAL). A secondary goal of the research is to then examine what RAPM and the inclusion of these two risk factors mean for other commonly used factors (like Value Premium, Capitalization Premium, and Momentum Premium) that are increasingly being added to portfolios in a new trend called “factor-based investing”. In many regressions, adding these two new factors either individually or together causes traditional factors like Capitalization and – in fewer cases – Momentum to lose their significance. Valuation continues to be significant even in tests where the SAA is heavily biased to include Value indices. These findings have interesting implications for improving portfolio performance especially in a low-yielding environment. Investors would do well to consider an intelligent approach to managing portfolio drift. With respect to factor-based investing, two results stand out: (i) Valuation seems to be a very robust strategy; and (ii) early movers probably benefit before these strategies get incorporated into the industry-wide SAA and then lose significance – a seemingly obvious result but validated in the context of a robust asset pricing model, thereby also serving as a first test of (a special case of) the Adaptive Markets Hypothesis.

Keywords: Relative Asset Pricing Model, RAPM, Fama-French, Factor-Based Investing, Asset Pricing Model Tests, Negative Risk Premia, Adaptive Markets Hypothesis

JEL Classification: G11, G12

Suggested Citation

Muralidhar, Arun and Savickas, Robert and Mao, Tzu-Jui, Asset Pricing Anomalies: Two Hedge Factors with Negative Risk Premia Embedded in Portfolios! (January 14, 2017). Available at SSRN: https://ssrn.com/abstract=2899418 or http://dx.doi.org/10.2139/ssrn.2899418

Arun Muralidhar (Contact Author)

AlphaEngine Global Investment Solutions ( email )

Great Falls, VA
United States

HOME PAGE: http://www.mcubeit.com

George Washington University ( email )

2121 I Street NW
Washington, DC 20052
United States

Robert Savickas

George Washington University - School of Business - Department of Finance ( email )

Funger Hall, Suite 501R
2201 G Street, N.W.
Washington, DC 20052
United States
202-994-8936 (Phone)
202-994-5014 (Fax)

HOME PAGE: http://savickas.net/

Tzu-Jui Mao

International Finance Corporations (IFC) ( email )

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