Future Security Returns and Factor Model Information Content Open Access
Weaver, Jonathan William (2010)
Published
Abstract
Abstract
Future Security Returns and Factor Model Information Content
By
Jonathan W. Weaver
In this paper I use the R-squared of a factor model estimated over
the prior five years to
examine whether future returns can be explained by a stock's past
ratio of explained
volatility to total volatility. I argue that the lack of success of
a factor model in providing
useful output creates an ambiguity premium that increases future
expected returns. I find
evidence that this is in fact the case, and for the 41 years from
1968 to 2008, the R-
squared from the factor loading estimation period is superior to
both idiosyncratic and
total risk in sorting future returns. Considering what is known
relative to what is
unknown for a stock's risk in a portfolio is a more precise measure
to examine a premium
for lack of information, or ambiguity. I find that R-squared also
is related to future risk
and is informative in predicting systematic risk estimation error.
The R-squared retains
predictive power while holding idiosyncratic, systematic, or total
risk quintiles constant.
Table of Contents
Table of Contents
1. Introduction 1
2. A Simulation of Calculated R-Squared and Beta 8
3. Data and Methodology 11
4. Empirical Findings 16
5. Alternative Measures of Model Uncertainty 27
6. Conclusion 29
References 32
Figures 35
Tables 36
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