Factor Timing with Portfolio Characteristics

Abstract

In a factor timing context, academic research has focused on identifying a set of predictors that can explain the dynamics of factor portfolios. We propose an alternative approach for timing factor portfolio returns by exploiting the information from their portfolio characteristics. Different combinations of dimension reduction techniques are employed to independently reduce both the number of predictors and portfolios to predict. Characteristic-based models outperform existing methods in terms of exact predictability, as well as investment performance.

Keywords: Return Predictability, Factor Portfolios, Dimension Reduction, Factor Timing, Anomalies

JEL Classification: G10, G11, C52, C55