Hedging Risk Factors

83 Pages Posted: 24 Mar 2018 Last revised: 28 Sep 2019

See all articles by Bernard Herskovic

Bernard Herskovic

University of California, Los Angeles (UCLA) - Anderson School of Management

Alan Moreira

University of Rochester - Simon Business School

Tyler Muir

University of California, Los Angeles (UCLA) - Anderson School of Management; National Bureau of Economic Research (NBER)

Date Written: January 14, 2019

Abstract

Standard risk factors can be hedged with minimal reduction in average returns. Stocks with low factor-exposure have similar performance relative to stocks with high factor-exposure, hence a long-short portfolio hedges factor risk with little reduction in expected returns. This is true for both “macro” factors relating to the business cycle, and “reduced-form” factors such as value and momentum. Hedging macro factors also hedges business cycle risk (e.g. NBER recessions) and hedges many other macro factors argued to be priced in the literature, and hedging “reduced-form: factors generates large alphas. Our results have implications for portfolio formation and for understanding the economic origins of equity risk premiums.

Keywords: Risk and Return, Equity Premium, Hedging, Asset Pricing Models, Factor Models

Suggested Citation

Herskovic, Bernard and Moreira, Alan and Muir, Tyler, Hedging Risk Factors (January 14, 2019). Available at SSRN: https://ssrn.com/abstract=3148693 or http://dx.doi.org/10.2139/ssrn.3148693

Bernard Herskovic

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

Los Angeles, CA 90095-1481
United States

HOME PAGE: http://bernardherskovic.com

Alan Moreira

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

Tyler Muir (Contact Author)

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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