Turbulence in the Cross-Section: Predicting Factor Premia

Abstract

Theories that explain the size of factor premia are rare. We show that parameter uncertainty based on the turbulence withing each cross-section of factor portfolios produces a significant out-of-sample forecast for six out of seven tested Fama-French risk factors, yielding the best predictor among a variety of popular predictors in five of these cases. Therefore, one measure predicts all the premia solely based on information contained in its own cross-section.

Keywords: factor premium, equity premium, forecasting, factor timing, style investing

JEL Classification: G12, G14, G17