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Factor return forecasting using cashflow spreads

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  • Dai, Yiqing
  • Haque, Tariq
  • Zurbruegg, Ralf

Abstract

We show the value of adding cashflow spreads to value spreads to forecast long/short factor returns. These spreads, namely the profitability and investment spreads, have significant forecasting power for a number of factors. Including these cashflow spreads also increases the predictive power of the value spread since it is a noisy measure of expected factor returns when used alone. Our results hold after controlling for macroeconomic variables and in out-of-sample tests. An implementable dynamic composite factor that adjusts its factor exposure according to the level of value and cashflow spreads has a Sharpe ratio that is nearly 50% higher than that of a static composite factor.

Suggested Citation

  • Dai, Yiqing & Haque, Tariq & Zurbruegg, Ralf, 2020. "Factor return forecasting using cashflow spreads," International Review of Economics & Finance, Elsevier, vol. 69(C), pages 917-931.
    • Handle: RePEc:eee:reveco:v:69:y:2020:i:c:p:917-931
    DOI: 10.1016/j.iref.2020.06.018
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    References listed on IDEAS

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    More about this item

    Keywords

    Value spread; Profitability spread; Investment spread; Factor returns;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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