Know Your VMS Exposure

摘要

One of the ongoing debates in equity market research is the set of common factors that explains the cross section of individual stock returns. With the influential backing of Fama and French [1993], a three-factor model that includes the market, size, and value factors is frequently cited in academic research and widely used in portfolio management. More recently, momentum has joined the list of accepted factors, resulting in references to a four-factor model. Lately, security volatility has begun to be used, along with the factors just mentioned, in describing portfolio risk.The authors introduce a specific measure of the idiosyncratic volatility factor that mirrors the Fama-French methodology, calling it VMS for volatile-minus-stable stocks. VMS is calculated for the entire span of the CRSP database and found to have strong credentials. VMS seems to be more important than SMB (small-minus-big market capitalization) and HML (high-minus-low book-to-market ratio), and similar to UMD (up-minus-down past return) in explaining the covariance structure of stock returns. The relative importance of VMS holds over the entire history for which it can be measured in the U.S. market (1931-2008) and continues to be an important factor in the covariance structure of stock returns in recent decades (1983-2008). Volatility, however, is not very orthogonal to the more well-known factors, a desirable property for new factors. Specifically,VMS is highly correlated to the general market (e.g., volatile stocks outperform stable stocks when the general equity market goes up) despite the fact that the authors measure security volatility in a market-idiosyncratic setting.VMS is also positively correlated with SMB (e.g., volatile stocks tendrnto outperform when small-cap stocks outperform) despite the Fama-French process of double sorting on market capitalization. Finally,VMS is negatively correlated with HML (e.g., volatile stocks tend to outperform when growth stocks outperform) although this correlation was not pronounced until the last few decades. In contrast to the other Fama-French factors, the average return of the VMS factor has been close to zero over time and negative in recent decades.