A macroeconomic hedge portfolio and the cross section of stock returns. Issue 1 (15th June 2020)

• Record Type: Journal Article
• Authors: Renz, Maximilian; Stotz, Olaf
• Is Part Of: Review of financial economics. Volume 39:Issue 1(2021)
• Page Start: 73
• Page End: 94
• Publication Date: 2020-06-15
• Subjects: asset pricing -- expected returns -- scheduled macroeconomic announcements -- macroeconomic hedge portfolio -- characteristic‐sorted risk factors; Business -- Periodicals; Economics -- Periodicals; Business; Economics; Electronic journals; Periodicals; 332.05
• DOI: 10.1002/rfe.1106
• Languages: English
• ISSNs: 1058-3300

Abstract

Abstract: We use a stock's returns on days when important macroeconomic news is released to form a hedge portfolio, which is long (short) in stocks which have a sensitive (insensitive) reaction to the surprise component of the macroeconomic news. This macroeconomic hedge portfolio (MHP) earns a risk premium of about 5% p.a. over time and a similar premium when used as a risk factor in an asset pricing model. This premium can be interpreted as a cost of an insurance against unexpected changes in an investor's marginal utility. We show that risk premiums associated with the MHP are estimated with a higher precision than traditional macroeconomic tracking portfolios. Furthermore, when the MHP is present in a common factor model, risk factors like high minus low lose much of their ability to explain the cross section of stock returns.