The Fama-French’s five-factor model relation with interest rates and macro variables

André Luis Leite, Marcelo Klotzle, Antonio Carlos Figueiredo Pinto and Claudio Henrique da Silveira Barbedo

The North American Journal of Economics and Finance, 2020, vol. 53, issue C

Abstract: Innovations in variables describing future investment opportunities command a risk premium and are correlated with Fama-French factors. As showed in literature, shocks to the aggregate dividend yield and term spread, default spread, and one-month T-bill rate are proxies for HML and SMB factors. However, in the context of five-factor model, they cannot explain RMW. As CPI is related to operational profitability, and so does RMW, we include its unanticipated shocks in the set of macro variables and factors to help explaining the cross section of returns. In the presence of CPI, RMW loses its explanatory power, and, combined with term structure’s slope innovations, all Fama-French factors lose their explanatory ability and the pricing errors become statistically close to zero. We show that for US data, inflation’s innovations not only proxy for RMW, but a model including only excess market returns, shocks to CPI and term structure’s slope explain the cross section of average returns better than innovations to the previous literature’s four-variable set and Fama-French five-factor model.

Keywords: Five-factor model; Macro Variables; Term Structure; Fama-French; Asset pricing (search for similar items in EconPapers)
JEL-codes: G12 G15 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecofin:v:53:y:2020:i:c:s1062940820300942

DOI: 10.1016/j.najef.2020.101197

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