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A common risk factor in global credit and equity markets: An exploratory analysis of the subprime and the sovereign-debt crises.

ABSTRACT: This paper investigates the existence of a common risk factor across asset classes and geographical areas, focusing on the crises and post-crisis periods. This factor has important implications for diversification in investor's portfolios. We assess a worldwide sample of assets: Equity, Corporate CDS and Sovereign CDS from fourteen countries across Europe, US and Asia, and focus the analysis to a time window where diversification was crucial: the crises and post-crisis periods. To identify the factors that underlie asset movements and their composition, a Principal Component Analysis (PCA) is applied. We find that there is supporting evidence for the existence of a common risk factor that underlies 86 percent of our sample' assets movements and reflects a global non-diversifiable risk that permeates the financial system. The uncovered risk factor is robust across periods, and it is evenly distributed across assets and countries, with the noticeable exception of Japan, which follows a divergent risk pattern. This is also true, to a lesser extent, for the US, Canada and China. Within the Eurozone financial assets a higher commonality is uncovered. In addition, we confirm that the common risk factor becomes more important in times of crisis. The existence of a common risk factor limits the possibilities of diversification, in particular during turmoil periods when correlations among assets' movements rise. However, the fact that some geographies display a lower commonality can be used to improve the risk profile of diversified portfolios.

SUBMITTER: Corzo T

PROVIDER: S-EPMC7270545 | biostudies-literature | 2020 Jun

REPOSITORIES: biostudies-literature

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A common risk factor in global credit and equity markets: An exploratory analysis of the subprime and the sovereign-debt crises.

Corzo Teresa T Lazcano Laura L Márquez Javier J Gismera Laura L Lumbreras Sara S

Heliyon 20200602 6

This paper investigates the existence of a common risk factor across asset classes and geographical areas, focusing on the crises and post-crisis periods. This factor has important implications for diversification in investor's portfolios. We assess a worldwide sample of assets: Equity, Corporate CDS and Sovereign CDS from fourteen countries across Europe, US and Asia, and focus the analysis to a time window where diversification was crucial: the crises and post-crisis periods. To identify the f ...[more]

PMID: 32518849

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Project description:ESG factors are becoming mainstream in portfolio investment strategies, attracting increasing fund inflows from investors who are aligning their investment values to Sustainable Development Goals (SDG) declared by the United Nations Principles for Responsible Investments. Do investors sacrifice return for pursuing ESG-aligned megatrend goals? The study analyses the risk-adjusted financial performance of ESG-themed megatrend investment strategies in global equity markets. The analysis covers nine themes for the period 2015-2019: environmental megatrends covering energy efficiency, food security, and water scarcity; social megatrends covering ageing, millennials, and urbanisation; governance megatrends covered by cybersecurity, disruptive technologies, and robotics. We construct megatrend factor portfolios based on signalling theory and formulate a novel measure for stock megatrend exposure (MTE), based on the relative fund flows into the corresponding thematic ETFs. We apply pure factor portfolios methodology based on constrained WLS cross-sectional regressions to calculate Fama-French factor returns. Time-series regression rests on the generalised method of moments estimator (GMM) that uses robust distance instruments. Our findings show that each environmental megatrend, as well as the disruptive technologies megatrend, yielded positive and significant alphas relative to the passive strategy, although this outperformance becomes statistically insignificant in the Fama-French 5-factor model context. The important result is that most of the megatrend factor portfolios yielded significant non-negative alphas; which supports our assumption that megatrend investing strategy promotes SDGs while not sacrificing returns, even when accounting for transaction costs up to 50bps/annum. Higher transaction costs, as is the case for some of these ETFs with expense ratios reaching 80-100bps, may be an indication of two things: ESG-themed megatrend investors were willing to sacrifice ca. 30-50bps of annual return to remain aligned with sustainability targets, or that expense ratio may well decline in the future.

Dataset Information

A common risk factor in global credit and equity markets: An exploratory analysis of the subprime and the sovereign-debt crises.

Publications

A common risk factor in global credit and equity markets: An exploratory analysis of the subprime and the sovereign-debt crises.

Similar Datasets

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