Characterizing the Tail-Risk of Factor Mimicking Portfolios
42 Pages Posted: 30 Jun 2019 Last revised: 7 Dec 2019
Date Written: June 27, 2019
Abstract
By assuming that short-run returns are independent and identically distributed, it is straightforward to extrapolate short-run risks to longer horizons. However, by generalizing the variance-ratio test to include higher co-moments, we establish a significant and sizable intertemporal dependency in all higher moments of equity returns. The intertemporal dependency is strong enough to prevent the convergence to normally distributed returns, at least up to a five-year holding period. We also demonstrate that the intertemporal dependency is both horizon \emph{and} portfolio-specific. Consequently, the common practice of extrapolating the short-run risk by assuming independent and identically distributed returns will severely bias the expected long-run risk.
Keywords: intertemporal dependency, risk factors, skewness, kurtosis, bootstrap
JEL Classification: G11, G12, C22, C12, C15, C58
Suggested Citation: Suggested Citation
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