Spectral Factor Models
57 Pages Posted: 13 Nov 2018 Last revised: 9 Jul 2019
Date Written: July 7, 2019
We represent risk factors as sums of orthogonal components capturing fluctuations over different frequencies. The representation leads to novel spectral factor models in which systematic risk is allowed (without being forced) to vary across different frequencies. Frequency-specific systematic risk is captured by a notion of spectral beta. We show that traditional factor models restrict the spectral betas to be constant. Spectral factor models dispense with this restriction and explicitly link its violation to the delayed reaction of prices to changes in the systematic factors. We illustrate how the methods may lead to dimension reduction in the factor space.
Keywords: systematic risk, factor models, investment horizon, portfolio optimization, cross-sectional pricing
JEL Classification: C22, C32, E32; G11; G12
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