Revisiting Fama–French factors' predictability with Bayesian modelling and copula‐based portfolio optimization

Yang Zhao, Charalampos Stasinakis* (Corresponding Author), Georgios Sermpinis, Filipa Da Silva Fernandes

*Corresponding author for this work

Research output: Contribution to journalArticle

Abstract

This study is investigating the predictability of the five Fama-French factors and explores their optimal portfolio allocation for factor investing during 2000-2017. Firstly, we forecast each factor with a pool of linear and non-linear models. Next, the individual forecasts are combined through Dynamic Model Averaging (DMA), while their performance is benchmarked by the best performing individual predictor and other forecast combination techniques. Finally, we use the Generalized Autoregressive Score (GAS) model and the skewed t copula method to estimate the correlation of assets. The GAS performance is also compared with other traditional approaches such as Dynamic Conditional Correlation (DCC) model and Asymmetric Dynamic Conditional Correlation (ADCC). The performance of the constructed portfolios is assessed through traditional metrics and ratios accounting for the Conditional Value-at-Risk (CVaR) and the Conditional Diversification Benefits (CDB) approach. Our results show that combining Bayesian forecast combinations with copulas is leading to significant improvements in the portfolio optimization process, while forecasting covariance accounting for asymmetric dependence between the factors adds diversification benefits to the obtained portfolios.
Original languageEnglish
Pages (from-to)1443-1463
Number of pages21
JournalInternational Journal of Finance and Economics
Volume24
Issue number4
Early online date5 Aug 2019
DOIs
Publication statusPublished - 1 Oct 2019

Keywords

  • Factor Investing
  • Portfolio Optimization
  • Dynamic Model Averaging
  • Forecast Combinations
  • forecast combinations
  • dynamic model averaging
  • factor investing
  • portfolio optimization
  • support vector regression
  • returns
  • risk
  • inflation
  • dynamics
  • krill herd
  • SUPPORT VECTOR REGRESSION
  • RETURNS
  • RISK
  • INFLATION
  • DYNAMICS
  • KRILL HERD

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