Zeta Risk and Future Stock Returns
June 12, 2017 - Equity Premium, Strategic Allocation, Volatility Effects
Can investors predict the return of a stock from its relationship with the dispersion of returns across all stocks? In their May 2017 paper entitled “Building Efficient Portfolios Sensitive to Market Volatility”, Wei Liu, James Kolari and Jianhua Huang examine a 2-factor model which predicts the return on a stock based on its sensitivity to (1) the value-weighted stock market return (beta risk) and (2) the standard deviation of value-weighted returns for all stocks (zeta risk). They first each month estimate zeta for each stock via regressions of daily data over the past year. They then rank stocks by zeta into quantile portfolios and calculate next-month equal-weighted returns across these portfolios and various long-short combinations of these portfolios (hedge portfolios) to measure dependence of future returns on zeta. Finally, they generate performance data for aggregate zeta risk portfolios by adding value-weighted market index returns to returns for each of the long-short zeta-sorted portfolios. Using daily and monthly returns for a broad sample of U.S. stocks in the top 90% of market capitalizations for that year, monthly equity market returns and monthly U.S. Treasury bill yields as the risk-free rate during January 1965 through December 2015, they find that: Keep Reading