What Matters in a Characteristic?

Abstract

We investigate how different components in firm characteristics affect expected returns and comovements in international stock markets. We decompose characteristics into country, industry, and adjusted components. Then, we use these components to capture time-series and cross-sectional variations in stock-level alphas and factor exposures. Decomposing characteristics is crucial to explain jointly expected returns and comovements: (i) adjusted (country) components are the most important determinant of alphas (comovements), (ii) component-based models outperform benchmark models, and (iii) alphas are statistically significant. However, alphas have been trending down over time, and alpha-chasing strategies are not profitable once we account for estimation risk and trading costs.

Keywords: IPCA, characteristics, country, industry, alpha, systematic risk.

JEL Classification: G12, G15.