Firm Characteristics, Stock Market Regimes, and the Cross-Section of Expected Returns

67 Pages Posted: 9 Feb 2020 Last revised: 12 Feb 2020

See all articles by Chris Kirby

Chris Kirby

UNC Charlotte - Belk College of Business

Date Written: January 5, 2020

Abstract

I propose a regime-switching generalization of instrumented principal components analysis (IPCA) that yields new insights about the relation between characteristics, factor loadings, and expected stock returns. Using a two-regime specification, I find evidence of a high-volatility regime in which individual stocks have high conditional expected returns. This contrasts sharply with the pattern of bull and bear regimes that is obtained by analyzing only market returns. Although exact factor pricing can be rejected, characteristics are more strongly related to priced covariances in the high-volatility regime. Furthermore, regime-switching predictability makes a substantial incremental contribution to the out-of-sample explanatory power of IPCA estimates.

Keywords: Markov switching, principal components analysis, factor model, cross-section of expected returns, price of covariance risk, Fama-MacBeth regressions

JEL Classification: C58, G11, G12

Suggested Citation

Kirby, Chris, Firm Characteristics, Stock Market Regimes, and the Cross-Section of Expected Returns (January 5, 2020). Available at SSRN: https://ssrn.com/abstract=3520131 or http://dx.doi.org/10.2139/ssrn.3520131

Chris Kirby (Contact Author)

UNC Charlotte - Belk College of Business ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

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