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The Fama-French’s five-factor model relation with interest rates and macro variables

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  • Leite, André Luis
  • Klotzle, Marcelo Cabus
  • Pinto, Antonio Carlos Figueiredo
  • da Silveira Barbedo, Claudio Henrique

Abstract

Innovations in variables describing future investment opportunities command a risk premium and are correlated with Fama-French factors. As showed in literature, shocks to the aggregate dividend yield and term spread, default spread, and one-month T-bill rate are proxies for HML and SMB factors. However, in the context of five-factor model, they cannot explain RMW. As CPI is related to operational profitability, and so does RMW, we include its unanticipated shocks in the set of macro variables and factors to help explaining the cross section of returns. In the presence of CPI, RMW loses its explanatory power, and, combined with term structure’s slope innovations, all Fama-French factors lose their explanatory ability and the pricing errors become statistically close to zero. We show that for US data, inflation’s innovations not only proxy for RMW, but a model including only excess market returns, shocks to CPI and term structure’s slope explain the cross section of average returns better than innovations to the previous literature’s four-variable set and Fama-French five-factor model.

Suggested Citation

  • Leite, André Luis & Klotzle, Marcelo Cabus & Pinto, Antonio Carlos Figueiredo & da Silveira Barbedo, Claudio Henrique, 2020. "The Fama-French’s five-factor model relation with interest rates and macro variables," The North American Journal of Economics and Finance, Elsevier, vol. 53(C).
    • Handle: RePEc:eee:ecofin:v:53:y:2020:i:c:s1062940820300942
    DOI: 10.1016/j.najef.2020.101197
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    2. Liu, Tengdong & Zheng, Dazhi & Zheng, Suyan & Lu, Yang, 2023. "Herding in Chinese stock markets: Evidence from the dual-investor-group," Pacific-Basin Finance Journal, Elsevier, vol. 79(C).
    3. Jareño, Francisco & González, María de la O & Escolástico, Alba M., 2020. "Extension of the Fama and French model: A study of the largest European financial institutions," International Economics, Elsevier, vol. 164(C), pages 115-139.

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    More about this item

    Keywords

    Five-factor model; Macro Variables; Term Structure; Fama-French; Asset pricing;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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