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Investing in the size factor

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  • Juan Laborda
  • Ricardo Laborda
  • Jose Olmo

Abstract

This paper investigates the role of the size factor for constructing investment portfolios and proposes a dynamic extension that accommodates the risk-free asset and time-varying weights. These weights are determined by a set of state variables given by the term structure of sovereign interest rates, variables describing market risk aversion such as the VIX index and the CRB Industrial return, and indexes reflecting investor sentiment towards the economic outlook. The empirical section explores the suitability of these state variables and analyses the out-of-sample performance of size factors idiosyncratic to the US, the UK and European financial markets that are compared against the dynamic version that optimizes the weights in each period. The results provide support to the different size factors except for periods of economic distress in which the optimal dynamic strategies are clearly superior.

Suggested Citation

  • Juan Laborda & Ricardo Laborda & Jose Olmo, 2016. "Investing in the size factor," Quantitative Finance, Taylor & Francis Journals, vol. 16(1), pages 85-100, January.
    • Handle: RePEc:taf:quantf:v:16:y:2016:i:1:p:85-100
    DOI: 10.1080/14697688.2015.1051098
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    Cited by:

    1. Laborda, Ricardo & Olmo, Jose, 2017. "Optimal asset allocation for strategic investors," International Journal of Forecasting, Elsevier, vol. 33(4), pages 970-987.
    2. Choi, Jungjun & Yang, Xiye, 2022. "Asymptotic properties of correlation-based principal component analysis," Journal of Econometrics, Elsevier, vol. 229(1), pages 1-18.

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