A0664
Title: Low-frequency risk factors and their fundamental drivers
Authors: Sicong Li - The Chinese University of Hong Kong (Hong Kong) [presenting]
Abstract: There is a zoo of factors that capture systematic risk premia and a large number of economic variables that explain their time variation, which poses a doubly high-dimensional challenge to understanding how economic fundamentals relate to the time-varying dynamics of risk premia. A method is proposed to regularize this problem by identifying low-frequency risk factors, whose risk premia are driven by latent low-frequency state variables. Empirically, one below-business-cycle-frequency factor and one business-cycle-frequency factor, whose variation concentrates on cycles longer than eight years and between 1.5 and eight years, explain the expected returns of individual stocks and characteristic-managed portfolios. The below-business-cycle-frequency factor has a high Sharpe ratio, and stocks whose current size is small compared to their long-term average load on it. Moreover, selected macroeconomic and financial variables have statistically and economically significant out-of-sample predictive power for the returns of the two low-frequency factors.
