Frequency Dependent Risks in the Factor Zoo
70 Pages Posted: 25 Oct 2021 Last revised: 20 Nov 2021
Date Written: October 22, 2021
I propose a novel framework to quantify frequency-dependent risks in the factor zoo. Empirically, the linear stochastic discount factor (SDF) comprised of the first few low-frequency principal components (PCs) yields an out-of-sample monthly Sharpe ratio of 0.37, and other smaller low-frequency PCs are redundant. In contrast, the SDFs consisting of high-frequency and canonical PCs are dense and fail to identify slow-moving conditional information in asset returns. Moreover, I decompose the low-frequency SDF into two orthogonal priced components. The first component, linear in high-frequency PCs, is almost serially uncorrelated and relates to discount-rate news, intermediary factors, jump risk, and investor sentiment. The second component exhibits a persistent conditional dynamic and captures business-cycle risks related to consumption and GDP growth. Overall, asset pricing theory has frequency-dependent relevance.
Keywords: Asset Pricing, Factor Models, Fourier transform, PCA.
JEL Classification: C14, G11, G12.
Suggested Citation: Suggested Citation