Future Security Returns and Factor Model Information Content Público
Weaver, Jonathan William (2010)
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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