The Economics of Factor Timing
61 Pages Posted: 5 Apr 2017 Last revised: 14 Jan 2019
Date Written: June 17, 2018
An optimal factor timing portfolio is equivalent to a conditional SDF. We use economic restrictions to determine and characterize both empirically. With these restrictions, we find that long-short equity factors are strongly and robustly predictable. A number of these portfolios have small or zero average price of risk, suggesting that the economic risks investors worry about conditionally are often very different from those they worry about on average. This manifests in the very different compositions of the conditional and unconditional SDFs. For bonds and foreign exchange strategies, long-short portfolios sorted on maturity or interest rate differential are also predictable.
Keywords: Predictability, Returns, Cross Section, Time Series, Equities, Bonds, Foreign Exchange
JEL Classification: G12, G14
Suggested Citation: Suggested Citation