Recovering Conditional Factor Risk Premia
44 Pages Posted: 1 Apr 2021
Date Written: November 13, 2020
We offer an approach for recovering option-implied time-varying forward-looking risk premia of systematic factors---even if they do not possess actively-traded options. We apply this approach to the market, size, value, and momentum factors. We find that factor premia are highly volatile. Both the market and the value premia tend to be higher during slowdowns and recessions and during turbulent times. By contrast, the momentum premium is higher during periods of high economic growth and low volatility. We use the recovered factor premia to construct trading strategies, which mitigate market and momentum crash risk and to predict returns of individual stocks even if they do not possess traded options.
Suggested Citation: Suggested Citation