Market Regimes, Sectorial Investments, and Time-Varying Risk Premiums

Peixin (Payton) Liu, Kuan Xu and Yonggan Zhao ()
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Yonggan Zhao: Department of Economics, Dalhousie University

Working Papers from Dalhousie University, Department of Economics

Abstract: This paper extends the Fama and French (FF) three factor model in studying time- varying risk premiums of Sector Select Exchange Traded Funds (ETFs) under a Markov regime-switching framework. First, we augment the original FF model to include three additional macro factors—market volatility, yield spread, and credit spread. Then, we extend this augmented FF model to a model with a Markov regime switching mechanism for bull, bear, and transition market regimes. We find all market regimes are persistent with the bull market regime being the most persistent and the bear market regime being the least persistent. Both the risk premiums of the Sector Select ETFs and their sensitivities to the risk factors are highly regime dependent. The regime-switching model has a superior performance in capturing the risk sensitivities of the Sector Select ETFs that would otherwise be missed by both the FF and the augmented FF models.

Keywords: Style Factors; Macro Economic Factors; Sector Exchange Traded Funds; State Dependance; Markov Regime Switching; Time-Varying Risk Premiums (search for similar items in EconPapers)
Pages: 40 pages
Date: 2010-06-28
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Citations: View citations in EconPapers (1)

Published in International Journal of Managerial Finance, 2011, pages 107-133

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http://wp.economics.dal.ca/RePEc/dal/wpaper/DalEconWP2010-05.pdf (application/pdf)

Related works:
Journal Article: Market regimes, sectorial investments, and time‐varying risk premiums (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:dal:wpaper:daleconwp2010-05

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