Macro-Finance and Factor Timing: Time-Varying Factor Risk and Price of Risk Premiums
55 Pages Posted: 26 Dec 2018 Last revised: 4 May 2020
Date Written: May 3, 2020
This paper unifies macro-finance and multifactor asset pricing theories to show that, in sample and out of sample: (i) Larger cross-sectional book-to-market medians and spreads - price of risk proxies - predict larger market (in sample), size, value, and investment premiums; (ii) the investment and profitability spreads - factor risk (quantity) proxies - only forecast the investment and profitability premiums, respectively, especially when conditioned on the price of risk. This predictability generates "factor timing" strategies with substantial economic gains, supports the hypothesis of time-varying price of risk in macro-finance theories, and contradicts the hypothesis that the investment and profitability "factors" have constant risks.
Keywords: Out of sample, factor timing, time-varying risk, macro-finance, Fama and French
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation