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

Peng Huang () and C. Hueng

Applied Financial Economics, 2009, vol. 19, issue 22, 1813-1824

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.

Date: 2009
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DOI: 10.1080/09603100903049674

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