Browsing by Author "Barroso, Pedro"
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- Crowding and tail risk in momentum returnsPublication . Barroso, Pedro; Edelen, Roger M.; Karehnke, PaulSeveral theoretical studies suggest that coordination problems can cause arbitrageur crowding to push asset prices beyond fundamental value as investors feedback trade on each others' emands. Using this logic we develop a crowding model for momentum returns that predicts tail risk when arbitrageurs ignore feedback effects. However, crowding does not generate tail risk when arbitrageurs rationally condition on feedback. Consistent with rational demands, our empirical analysis generally finds a negative relation between crowding proxies constructed from institutional holdings and expected crash risk. Thus our analysis casts both theoretical and empirical doubt on crowding as a stand-alone source of tail risk.
- Lest we forget: learn from out-of-sample errors when optimizing portfoliosPublication . Barroso, Pedro; Saxena, KonarkPortfolio optimization often struggles in realistic out-of-sample contexts. We de-construct this stylized fact, comparing historical forecasts of portfolio optimization inputs with subsequent out of sample values. We confirm that historical forecasts are imprecise guides of subsequent values but also find the resulting forecast errors are not entirely random. They have predictable patterns and can be partially reduced using their own history. Learning from past forecast errors to calibrate inputs (akin to empirical Bayesian learning) results in portfolio performance that reinforces the case for optimization. Furthermore, the portfolios achieve performance that meets expectations, a desirable yet elusive feature of optimization methods.
- The risk-return tradeoff among equity factorsPublication . Barroso, Pedro; Maio, PauloWe examine the time-series risk-return trade-off among equity factors. We obtain a positive tradeoff for profitability and investment factors. Such relationship subsists conditional on the covariance with the market factor, which represents consistency with Merton’s ICAPM. Critically, we obtain an insignificant risk-return relationship for the market factor. The factor risk-return trade-off tends to be weaker among international equity markets. The out-of-sample forecasting power (of factor variances for future own returns) tends to be economically significant for the investment and profitability factors. Our results suggest that the risk-return trade-off is stronger within segments of the stock market than for the whole.
- The risk–return tradeoff among equity factorsPublication . Barroso, Pedro; Maio, PauloWe examine the time-series risk–return tradeoff among equity factors. We obtain a positive tradeoff for profitability and investment factors, which is consistent with the APT. Such relationship subsists when we control by the covariance with the market factor, which represents consistency with Merton's ICAPM. Critically, we obtain an insignificant risk–return relationship for the market and other factors. The tradeoff is weaker among international equity markets. The out-of-sample forecasting power tends to be economically significant for the investment and profitability factors. Our results suggest that the risk–return tradeoff is stronger within segments of the stock market than for the whole.
- The volatility puzzle of the beta anomalyPublication . Barroso, Pedro; Detzel, Andrew; Maio, PauloThis paper shows that leading theories of the beta anomaly fail to explain the anomaly's conditional performance. Abnormal returns and Sharpe ratios of betting-against-beta (BAB) factors rise following months with below-median realized volatility, even controlling for mispricing, limits to arbitrage, lottery preferences, analyst disagreement, and sentiment. Moreover, the leverage constraints theory counterfactually predicts that market and BAB Sharpe ratios increase with volatility. We further show that institutional investors shift their demand from high- to low-beta stocks as volatility increases, and the resulting price impact is sufficient to explain the difference in abnormal BAB returns between high- and low-volatility states.