One Vol to Rule Them All: Common Volatility Dynamics in Factor Returns
62 Pages Posted: 15 Jun 2020 Last revised: 5 Aug 2021
Date Written: August 4, 2021
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: Suggested Citation