A macroeconomic hedge portfolio and the cross section of stock returns

Maximilian Renz and Olaf Stotz

Review of Financial Economics, 2021, vol. 39, issue 1, 73-94

Abstract: We use a stock's returns on days when important macroeconomic news is released to form a hedge portfolio, which is long (short) in stocks which have a sensitive (insensitive) reaction to the surprise component of the macroeconomic news. This macroeconomic hedge portfolio (MHP) earns a risk premium of about 5% p.a. over time and a similar premium when used as a risk factor in an asset pricing model. This premium can be interpreted as a cost of an insurance against unexpected changes in an investor's marginal utility. We show that risk premiums associated with the MHP are estimated with a higher precision than traditional macroeconomic tracking portfolios. Furthermore, when the MHP is present in a common factor model, risk factors like high minus low lose much of their ability to explain the cross section of stock returns.

Date: 2021
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https://doi.org/10.1002/rfe.1106

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Persistent link: https://EconPapers.repec.org/RePEc:wly:revfec:v:39:y:2021:i:1:p:73-94

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