Interest-Rate Risk Factor and Stock Returns: A Time-Varying Factor-Loadings Model

Document Type

Article

Publication Date

11-1-2009

Department

School of Business

Abstract

We extend the Fama-French three-factor model to include a risk factor that proxies for interest-rate risk faced by firms in an attempt to reduce the pricing errors that the three-factor model cannot explain. These pricing errors are observed especially in small size and low book-to-market ratio firms, which are in general more sensitive to interest-rate risk. In addition, the factor loadings are modelled as time-varying so that the investors' learning process can be taken into account. The results show that our Time-Varying-Loadings Four-Factor (TVL4) model significantly reduces the pricing errors. © 2009 Taylor & Francis.

DOI

10.1080/09603100903049674

First Page

1813

Last Page

1824

Volume

19

Issue

22

ISSN

09603107

Comments

At the time of publication, Peng Huang was affiliated with Ripon College.

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