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Characteristic-sorted portfolios and macroeconomic risks—An orthogonal decomposition

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  • Adcock, Christopher
  • Bessler, Wolfgang
  • Conlon, Thomas

Abstract

We assess the relative importance of individual macroeconomic variables in explaining the time series variation of a broad range of characteristic-sorted portfolios. Employing an optimal orthogonalization approach, the explained variation in each characteristic-sorted portfolio is decomposed into components associated with individual macroeconomic variables. When examined unconditionally, the set of macroeconomic variables account for only limited explained variation. This low explained variation is partially resolved by allowing for dynamic and non-linear macroeconomic exposure. Finally, we highlight a degree of commonality in the explained macroeconomic variation associated with various characteristic-sorted portfolios, indicating that they proxy for particular macroeconomic characteristics simultaneously.

Suggested Citation

  • Adcock, Christopher & Bessler, Wolfgang & Conlon, Thomas, 2022. "Characteristic-sorted portfolios and macroeconomic risks—An orthogonal decomposition," Journal of Empirical Finance, Elsevier, vol. 65(C), pages 24-50.
    • Handle: RePEc:eee:empfin:v:65:y:2022:i:c:p:24-50
    DOI: 10.1016/j.jempfin.2021.11.001
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    More about this item

    Keywords

    Characteristic-sorted portfolios; Macroeconomic fundamentals; Variance decomposition;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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