Understanding Factor Value

Shaojun Zhang

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: The value spread of factors fluctuates over time because of changes in market equity or book value but predicts factor returns only through the component driven by market equity changes (the dme spread). Exploiting cross-sectional mispricing, the dme spread captures 90 years of sentiment and subsumes the predictability in existing sentiment measure. Factor predictability concentrates on factors most predictable by sentiment and factors more subject to asymmetric limits of arbitrage. A factor value strategy exploiting the predictability outperforms and explains cross-sectional value factors. The value premium is not an independent factor but summarizes time-varying factor returns conditional on sentiment.

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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2024-05

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