Persistent and Transitory Components of Characteristics: Implications for Asset Pricing

87 Pages Posted: 6 Mar 2020 Last revised: 14 Feb 2023

See all articles by Fahiz Baba Yara

Fahiz Baba Yara

Indiana University - Kelley School of Business

Martijn Boons

Tilburg University

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Date Written: January 31, 2020

Abstract

We study the horizon-dimension of cross-sectional return predictability through the lens of a model where characteristics contain persistent and transitory components. We test the implications of this model for the average returns of popular characteristic-based trading strategies at short versus long horizons after portfolio formation. Our evidence supports the claim that the relative compensation for persistent and transitory components varies across characteristics, in magnitude and sign. Benchmark factor models cannot explain the returns of portfolios sorted on characteristics where either the persistent or transitory component is dominant. Finally, we model and test implications for firms' long-term discount rates.

Keywords: Characteristics, Persistent-Transitory Decomposition, Cross-Sectional Return Predictability, Discount Rates, Asset Pricing Tests

JEL Classification: G11, G12

Suggested Citation

Baba Yara, Fahiz and Boons, Martijn and Tamoni, Andrea, Persistent and Transitory Components of Characteristics: Implications for Asset Pricing (January 31, 2020). Available at SSRN: https://ssrn.com/abstract=3529140 or http://dx.doi.org/10.2139/ssrn.3529140

Fahiz Baba Yara

Indiana University - Kelley School of Business ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

HOME PAGE: http://www.babayara.com

Martijn Boons (Contact Author)

Tilburg University ( email )

P.O. Box 90153
Tilburg, DC Noord-Brabant 5000 LE
Netherlands

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
760
Abstract Views
3,332
Rank
57,860
PlumX Metrics