US structural drivers of international portfolio returns

• Published in: The North American journal of economics and finance 2023-01, Vol.64, p.101872, Article 101872
• Main Authors: Jang, Bosung, So, Inhwan, Tong, Eric
• Format: Article
• Language: English
• Subjects: Cross-sectional test; Fama–French factors; Growth shocks; Local projections; Monetary policy shocks; Risk premium shocks; Sign restriction
• ISSN: 1062-9408; 1879-0860
• DOI: 10.1016/j.najef.2022.101872

•Fama-French factors respond to structural shocks in a differentiated manner.•Different Fama-French factors compensate for different types of systematic and undiversifiable risks.•Factor investors should view excess returns as compensations for risks rather than alpha returns or ‘free lunch’. This paper examines the dynamic relationships between the global six Fama–French and momentum factors and three types of shocks from the US: growth, monetary policy, and risk premium shocks. Cross-sectional tests suggest that the US shocks capture a significant portion of the six factors’ explanatory power. Investigating the dynamic relationships, we find that although the market portfolio and small-minus-big style appreciate in value in response to positive growth shocks, the remaining factors—high-minus-low, conservative-minus-aggressive, robust-minus-weak, and winning-minus-losing—are not responsive or respond positively to the negative shocks. Internationally, the factors can respond heterogeneously to the same shock. By mapping risks to returns, our work paves the way for a detailed exploration of the structural drivers of excess equity returns.