Macro-Finance and Factor Timing: Time-Varying Factor Risk and Price of Risk Premiums
Discussion Papers on Business and Economics, University of Southern Denmark, 7/2019
42 Pages Posted: 15 May 2019
Date Written: May 13, 2019
This paper documents empirically that increases in the book-to-market spread predict larger market premiums in sample and larger size, value, and investment premiums (also) out of sample. In addition, increases in the investment (or profitability) spread exclusively predict larger investment (or profitability) premiums. This predictability generates “factor timing” strategies that deliver substantial economic gains out of sample. I argue theoretically that the book-to-market spread is a price of risk proxy, while the investment and profitability spreads are factor risk proxies. The evidence confirms standard theoretical predictions in the macro-finance literature and contradicts the hypothesis of constant factor risks.
Keywords: Out of Sample, Factor Timing, Time-Varying Risk, Macro-Finance, Fama and French
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation