Macroeconomic factors strike back: A Bayesian change-point model of time-varying risk exposures and premia in the U.S. cross-section
AbstractThis paper proposes a Bayesian estimation framework for a typical multi-factor model with time-varying risk exposures to macroeconomic risk factors and corresponding premia to price U.S. stocks and bonds. The model assumes that risk exposures and idiosynchratic volatility follow a break-point latent process, allowing for changes at any point in time but not restricting them to change at all points. An empirical application to 40 years of U.S. data and 23 portfolios shows that the approach yields sensible results compared to previous two-step methods based on naive recursive estimation schemes, as well as a set of alternative model restrictions. A variance decomposition test shows that although most of the predictable variation comes from the market risk premium, a number of additional macroeconomic risks, including real output and inflation shocks, are significantly priced in the cross-section. A Bayes factor analysis decisively favors the proposed change-point model.
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Bibliographic InfoPaper provided by Norges Bank in its series Working Paper with number 2013/19.
Length: 52 pages
Date of creation: 22 Aug 2013
Date of revision:
Change-point model; Stochastic volatility; Multi-factor linear models;
Find related papers by JEL classification:
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-08-31 (All new papers)
- NEP-ECM-2013-08-31 (Econometrics)
- NEP-ORE-2013-08-31 (Operations Research)
- NEP-RMG-2013-08-31 (Risk Management)
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