Using Cashflow and Value Spreads to Forecast Long/Short Factor Returns
34 Pages Posted: 5 Nov 2018
Date Written: September 19, 2018
We show the value of adding cashflow spreads to value spreads to forecast long/short factor returns. These spreads, namely the profitability and investment spreads, have significant forecasting power for a number of factors. Including cashflow spreads also increases the predictive power of the value spread since it is a noisy measure of expected factor returns when used alone. Our results hold after controlling for macroeconomic variables and in out-of-sample tests. We also combine the value spread with the profitability and investment spreads to create a parsimonious measure, the composite characteristic spread, that has strong predictive power for many long/short anomalies.
Keywords: Value Spread, Profitability Spread, Investment Spread, Composite Characteristic Spread, Factor Returns
JEL Classification: G11, G12
Suggested Citation: Suggested Citation