From macro to micro: Sparse macroeconomic risks and the cross-section of stock returns

Lin Zhu, Fuwei Jiang, Guohao Tang and Fujing Jin

International Review of Financial Analysis, 2024, vol. 95, issue PB

Abstract: Our study presents novel evidence on the pricing effectiveness of macroeconomic risks at the firm level. We employ a sparse PCA approach to aggregate macroeconomic variables from the FRED-MD database and obtain the first eight components, namely inflation, housing, spreads, production, employment, personal income, yields, and credit. We then construct the corresponding firm-level macroeconomic risk exposures as the sensitivity of the individual stock returns to the sparse economic components. Our research yields three main findings: (i) macro betas cannot be fully captured by common firm fundamentals, indicating the unique information in macro betas; (ii) the betas of inflation, production, personal income, yields, and credit are strong predictors of future stock returns beyond other micro risks; and (iii) behavioral mispricing theory, especially arbitrage frictions and investor sentiment, can help explain the macro beta premium.

Keywords: Macroeconomic risks; Cross-sectional stock returns; Sparse PCA; Mispricing (search for similar items in EconPapers)
JEL-codes: C43 C82 E01 G11 G12 G41 (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:95:y:2024:i:pb:s105752192400365x

DOI: 10.1016/j.irfa.2024.103433

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