The Risk-Return Tradeoff Among Equity Factors

35 Pages Posted: 16 Jul 2017  

Pedro Barroso

UNSW Australia Business School, School of Banking and Finance

Paulo F. Maio

Hanken School of Economics - Department of Finance and Statistics

Multiple version iconThere are 3 versions of this paper

Date Written: January 2017

Abstract

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

Barroso, Pedro and Maio, Paulo F., The Risk-Return Tradeoff Among Equity Factors (January 2017). Available at SSRN: https://ssrn.com/abstract=3003357

Pedro Barroso

UNSW Australia Business School, School of Banking and Finance ( email )

Sydney, NSW 2052
Australia

Paulo F. Maio (Contact Author)

Hanken School of Economics - Department of Finance and Statistics ( email )

FI-00101 Helsinki
Finland

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