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Interest-rate risk factor and stock returns: a time-varying factor-loadings model

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  • Peng Huang
  • C. James Hueng

Abstract

We extend the Fama-French three-factor model to include a risk factor that proxies for interest-rate risk faced by firms in an attempt to reduce the pricing errors that the three-factor model cannot explain. These pricing errors are observed especially in small size and low book-to-market ratio firms, which are in general more sensitive to interest-rate risk. In addition, the factor loadings are modelled as time-varying so that the investors' learning process can be taken into account. The results show that our Time-Varying-Loadings Four-Factor (TVL4) model significantly reduces the pricing errors.

Suggested Citation

  • Peng Huang & C. James Hueng, 2009. "Interest-rate risk factor and stock returns: a time-varying factor-loadings model," Applied Financial Economics, Taylor & Francis Journals, vol. 19(22), pages 1813-1824.
  • Handle: RePEc:taf:apfiec:v:19:y:2009:i:22:p:1813-1824
    DOI: 10.1080/09603100903049674
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    References listed on IDEAS

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    1. Franzoni, Francesco, 2006. "Where is beta going ? the riskiness of value and small stocks," Les Cahiers de Recherche 829, HEC Paris.
    2. Francesco Franzoni, 2006. "Where is Beta Going ? The Riskiness of Value and Small Stocks," Post-Print halshs-00125691, HAL.
    3. Francesco Franzoni, 2006. "Where is Beta Going ? The Riskiness of Value and SmallStocks," Post-Print halshs-00009862, HAL.
    4. Chang-Jin Kim & Charles R. Nelson, 1999. "State-Space Models with Regime Switching: Classical and Gibbs-Sampling Approaches with Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262112388, January.
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    Cited by:

    1. Jacques Peeperkorn & Yudhvir Seetharam, 2016. "A learning-augmented approach to pricing risk in South Africa," Eurasian Business Review, Springer;Eurasia Business and Economics Society, vol. 6(1), pages 117-139, April.
    2. repec:bla:manchs:v:85:y:2017:i:2:p:212-242 is not listed on IDEAS

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