One Vol to Rule Them All: Common Volatility Dynamics in Factor Returns

62 Pages Posted: 15 Jun 2020 Last revised: 5 Aug 2021

See all articles by Nishad Kapadia

Nishad Kapadia

Tulane University - Finance & Economics

Matthew Linn

Isenberg School of Management, University of Massachusetts

Bradley S. Paye

Virginia Polytechnic Institute & State University - Department of Finance, Insurance, and Business Law

Date Written: August 4, 2021

Abstract

We show that a common component governs volatility dynamics across a wide range of traded equity factors. This `common factor volatility' (CFV) exists even among orthogonal factors. CFV occurs in both cash-flow and discount-rate components of factor returns and derives from market responses to fundamental news rather than underlying commonality in news volatility. Incorporating CFV improves factor volatility forecasts relative to models that include only own-factor volatility. The pervasiveness of CFV helps characterize the dynamics of stochastic discount factor (SDF) volatility. CFV results in conditional SDFs that exhibit procyclical volatility, highlighting an inconsistency between traded factors and prominent macro models.

Keywords: Volatility, Predictability, Equities, Discount Rate News, Cash Flow News

JEL Classification: G00, G10, G12, E17, E27, C58

Suggested Citation

Kapadia, Nishad and Linn, Matthew and Paye, Bradley S., One Vol to Rule Them All: Common Volatility Dynamics in Factor Returns (August 4, 2021). Available at SSRN: https://ssrn.com/abstract=3606637 or http://dx.doi.org/10.2139/ssrn.3606637

Nishad Kapadia

Tulane University - Finance & Economics ( email )

A.B. Freeman School of Business
7 McAlister Drive
New Orleans, LA 70118
United States
504-314-7454 (Phone)

Matthew Linn (Contact Author)

Isenberg School of Management, University of Massachusetts ( email )

Amherst, MA 01003
United States

Bradley S. Paye

Virginia Polytechnic Institute & State University - Department of Finance, Insurance, and Business Law ( email )

1016 Pamplin Hall (0221)
Blacksburg, VA 24060-0221
United States

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