The Cross-Section of Asset Synchronicity by Elastic-Net

83 Pages Posted: 1 Jan 2019

See all articles by Raymond C. W. Leung

Raymond C. W. Leung

Cheung Kong Graduate School of Business

Yu-Man Tam

Office of the Comptroller of the Currency, Department of the Treasury

Date Written: December 13, 2018

Abstract

How does one hedge factor risks without knowing the identities of the factors? We first prove a general theoretical result: even if the exact set of factors cannot be identified by the econometrician, any risky asset can use some portfolio of other similar risky assets to insure against its own factor exposures. A long position of a given risky asset and a short position of this portfolio represents this asset’s residual factor risks. We coin the expected return of this long-short position as an asset insurance premium. To empirically construct this portfolio, we regress a given stock’s return onto the returns of thousands of all other stocks using the elastic-net estimator, a machine learning method. We coin the regression R-squared as asset synchronicity. Unique stocks earn a higher return than ubiquitous stocks: in the cross-section, value-weighted stocks that are least (most) synchronized with all other stocks earn an asset insurance premium of 0.976% (0.305%) per month. The unconditional value-weighted asset insurance premium is positive and economically large at 0.575% per month. Asset synchronicity is countercyclical, where a 1% monthly change in macroeconomic consumption shocks is associated with a -1.725% change in the cross-sectional asset insurance premium. The unconditional and cross-sectional existence of the asset insurance premium is robust to equal and value portfolio weighting schemes, and to the effects of value, size, idiosyncratic volatility and illiquidity measures.

Keywords: Cross-section, elastic-net, machine learning, asset synchronicity, asset insurance premium, macrofinance, portfolio construction

JEL Classification: G11, G12, C55

Suggested Citation

Leung, Raymond C. W. and Tam, Yu-Man, The Cross-Section of Asset Synchronicity by Elastic-Net (December 13, 2018). Available at SSRN: https://ssrn.com/abstract=3300769 or http://dx.doi.org/10.2139/ssrn.3300769

Raymond C. W. Leung (Contact Author)

Cheung Kong Graduate School of Business ( email )

3F, Tower E3, Oriental Plaza
1 East Chang An Avenue
Beijing, Beijing 100738
China

HOME PAGE: http://sites.google.com/site/raymondcwleung123/

Yu-Man Tam

Office of the Comptroller of the Currency, Department of the Treasury ( email )

400 7th Street SW
Washington, DC 20219
United States
202-649-5671 (Phone)

Register to save articles to
your library

Register

Paper statistics

Downloads
81
rank
296,179
Abstract Views
479
PlumX Metrics