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The Joint Dynamics of Equity Market Factors

Peter Christoffersen and Hugues Langlois ()
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Hugues Langlois: McGill University - Desautels Faculty of Management, Postal: 1001 Sherbrooke St. W, Montreal, Quebec H3A 1G5, Canada

CREATES Research Papers from Department of Economics and Business Economics, Aarhus University

Abstract: The four equity market factors from Fama and French (1993) and Carhart (1997) are perva- sive in academic empirical asset pricing studies and in applied portfolio allocation. However, the joint distributional dynamics of the factors are rarely studied. For investors basing strate- gies on the factors or using them to model the returns of a wider set of assets, proper risk management requires knowing the joint factor dynamics which we model. We ?nd striking ev- idence of asymmetric tail dependence across the factors. While the linear factor correlations are small and even negative, the extreme correlations are large and positive, so that the linear correlations drastically overstate the bene?ts of diversi?cation across the factors. We model the nonlinear factor dependence and explore its economic importance in a portfolio allocation experiment which shows that signi?cant economic value is earned when acknowledging the nonlinear dependence.

Keywords: Factors; threshold correlation; copulas; portfolio optimization; asymmetry. (search for similar items in EconPapers)
JEL-codes: C01 G11 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk and nep-rmg
Date: 2011-09-09
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Journal Article: The Joint Dynamics of Equity Market Factors (2013) Downloads
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