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Persistent and transitory components of firm characteristics: Implications for asset pricing

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  • Baba-Yara, Fahiz
  • Boons, Martijn
  • Tamoni, Andrea

Abstract

We study the horizon dimension of cross-sectional return predictability using a model where characteristics contain both persistent and transitory components. We test the implications of this model for the average returns of popular characteristic-based trading strategies at short versus long horizons after portfolio formation. Our evidence supports the claim that the relative compensation for persistent and transitory components varies across characteristics, in both magnitude and sign. Benchmark factor models cannot explain the returns of portfolios sorted on characteristics where either the persistent or transitory component is dominant. Finally, we discuss implications for the long-term discount rates of firms.

Suggested Citation

  • Baba-Yara, Fahiz & Boons, Martijn & Tamoni, Andrea, 2024. "Persistent and transitory components of firm characteristics: Implications for asset pricing," Journal of Financial Economics, Elsevier, vol. 154(C).
    • Handle: RePEc:eee:jfinec:v:154:y:2024:i:c:s0304405x2400031x
    DOI: 10.1016/j.jfineco.2024.103808
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    More about this item

    Keywords

    Characteristics; Persistent-transitory decomposition; Cross-section; Return predictability; Discount rates;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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