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The Joint Dynamics of Equity Market Factors

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  • Peter Christoffersen

    ()
    (University of Toronto - Rotman School of Management and CREATES)

  • Hugues Langlois

    ()
    (McGill University - Desautels Faculty of Management)

Abstract

The four equity market factors from Fama and French (1993) and Carhart (1997) are perva- sive in academic empirical asset pricing studies and in applied portfolio allocation. However, the joint distributional dynamics of the factors are rarely studied. For investors basing strate- gies on the factors or using them to model the returns of a wider set of assets, proper risk management requires knowing the joint factor dynamics which we model. We ?nd striking ev- idence of asymmetric tail dependence across the factors. While the linear factor correlations are small and even negative, the extreme correlations are large and positive, so that the linear correlations drastically overstate the bene?ts of diversi?cation across the factors. We model the nonlinear factor dependence and explore its economic importance in a portfolio allocation experiment which shows that signi?cant economic value is earned when acknowledging the nonlinear dependence.

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Bibliographic Info

Paper provided by School of Economics and Management, University of Aarhus in its series CREATES Research Papers with number 2011-45.

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Length: 49
Date of creation: 09 Sep 2011
Date of revision:
Handle: RePEc:aah:create:2011-45

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Web page: http://www.econ.au.dk/afn/

Related research

Keywords: Factors; threshold correlation; copulas; portfolio optimization; asymmetry.;

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