Factor Covariances Predict Factor Returns

Nigel J. Barradale, Søren Hvidkjær

Research output: Working paperResearch


We examine low-turnover zero-investment “factor” portfolios constructed from various stock characteristics previously shown to predict returns. The nine different factor portfolios all exhibit negative market betas. Our central result is that a more negative beta across factors predicts higher factor returns over the next two years. Similarly, the average relative volatility of the factor returns, as well as the cross-sectional variance of the betas and volatilities, predicts future factor returns. While the results are difficult to reconcile with standard risk-based explanations, they are consistent with the existence of a time-varying mass of naïve investors, whose trading affects the returns to characteristics-based factor portfolios. Indeed, the average beta across factors is highly negatively correlated across time with the Baker and Wurgler (2006) investor sentiment measure.
Original languageEnglish
Place of PublicationFrederiksberg
PublisherCopenhagen Business School [wp]
Number of pages47
Publication statusPublished - 2013


  • Factor returns
  • Factor covariances
  • Investor sentiment
  • Time-series predictability

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