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The Joint Dynamics of Equity Market Factors

Published online by Cambridge University Press:  18 December 2013

Peter Christoffersen  and
Hugues Langlois
Peter Christoffersen*
Affiliation:
peter.christoffersen@rotman.utoronto.ca, Rotman School of Management, University of Toronto, 105 St George Street, Toronto, ON, M5S 3E6 Canada, Copenhagen Business School and Center for Research in Econometric Analysis of Time Series (CREATES), Aarhus University
Hugues Langlois*
Affiliation:
hugues.langlois@mail.mcgill.ca, Desautels Faculty of Management, McGill University, 1001 Sherbrooke St W, Montreal, QC, H3A 1G5 Canada.
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Abstract

The 4 equity market factors from Fama and French (1993) and Carhart (1997) are pervasive in academia and practice. However, not much is known about their joint distribution and dynamics. We find striking evidence 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 benefits of diversification across the factors. We model the nonlinear factor dependence dynamics and explore their economic importance in a portfolio allocation experiment showing that significant economic value is earned when acknowledging nonlinear dependence.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 48 , Issue 5 , October 2013 , pp. 1371 - 1404
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2013 

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