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Focus on Global Factors?

December 14, 2023 • Posted in Equity Premium

Should investors focus on global equity factors or local (country) equity factors when trying to predict their local market returns? In their November 2023 paper entitled “How Global is Predictability? The Power of Financial Transfer Learning”, Oliver Hellum, Lasse Heje Pedersen and Anders Rønn-Nielsen compare the importance of global factors versus local factors for predicting local stock market returns in 35 countries. They generate optimal local and global factor models using the generalized elastic net usually trained in an early subsample and tested in a later subsample. They perform an array of tests:

  • For each country, they compare predictive powers of local and global factor models optimized pre-2000 and tested during 2000-2021.
  • For each country, they compare predictive powers of local and U.S. factor models optimized pre-2000 and tested during 2000-2021.
  • They check the predictive power of a non-U.S. factor model optimized during 1982-2021 and tested in the U.S. during 1926-1981.

Using trimmed monthly returns in U.S. dollars and most of the 153 firm characteristics (inputs) used in prior research for broad samples of firms/stocks since 1926 for the U.S. and since 1982 as available for 34 other countries, all through 2021, they find that:

(more…)

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