35 Pages Posted: 16 Jul 2017
Date Written: January 2017
We examine the risk-return trade-off among equity factors. We obtain a positive in-sample risk-return trade-off for the profitability (RMW) and investment (CMA) factors of Fama and French (2015, 2016), while for the market and momentum factors there is a negative relation. The out-of-sample forecasting power (of factor volatility for factor returns) is economically significant for both RMW and CMA: By constructing a trading strategy that relies on such predictability, we obtain annual Sharpe ratios above one and utility gains above 5% per year. We also find weak evidence that the factor variances are negatively correlated with the aggregate equity premium.
Keywords: Asset pricing, risk-return tradeoff, risk factors, market anomalies, realized volatility, predictability of stock returns, profitability, asset growth
JEL Classification: G11; G12; G17
Suggested Citation: Suggested Citation
Barroso, Pedro and Maio, Paulo F., The Risk-Return Tradeoff Among Equity Factors (January 2017). Available at SSRN: https://ssrn.com/abstract=3003357