Macroeconomic Fundamentals and the Pricing of Anomaly Portfolios

43 Pages Posted: 2 Aug 2021

See all articles by Rajesh Tharyan

Rajesh Tharyan

University of Exeter Business School

Date Written: September 25, 2020

Abstract

The consensus is that asset pricing models with macroeconomic factors perform poorly, relative to firm-characteristic-based factor models, in explaining the cross-section of stock and bond returns. This is a disconcerting result if the “central task of asset pricing” is to demonstrate the link between macro risk factors and asset returns. I propose a model with a set of factors that mimic underlying fundamental sources of risk in the economy. These factors are extracted using a novel stock-level sort that preserves the relation between stocks and a large set of macroeconomic variables. This model performs at least as well as standard characteristic-based factor models in explaining the cross-section of common benchmark and anomaly portfolio spreads. Taken together, the evidence shows that macroeconomic factors are useful in explaining the cross-section of stock and bond returns.

Keywords: Asset Pricing, Factor Models, Anomaly

JEL Classification: G12

Suggested Citation

Tharyan, Rajesh, Macroeconomic Fundamentals and the Pricing of Anomaly Portfolios (September 25, 2020). Available at SSRN: https://ssrn.com/abstract=3699337 or http://dx.doi.org/10.2139/ssrn.3699337

Rajesh Tharyan (Contact Author)

University of Exeter Business School ( email )

Northcote House
The Queen's Drive
Exeter, Devon EX4 4QJ
United Kingdom

HOME PAGE: http://business-school.exeter.ac.uk/about/people/profile/index.php?web_id=Rajesh_Tharyan

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