Value has been recognised as one of the most important factors for equities since the pioneering work by Fama and MacBeth (1973). In equities, the book-to-market value ratio has traditionally been ...
Value has been recognised as one of the most important factors for equities since the pioneering work by Fama and MacBeth (1973). In equities, the book-to-market value ratio has traditionally been used as a proxy for the value factor. Natural as this choice is for this asset class, it is difficult to translate the concept of value to the ﬁxed-income domain.
In this paper, “Factor Investing in Fixed-Income – Defining and Exploiting Value in Sovereign Bond Markets”, we propose a deﬁnition of value in Treasury bonds that, we believe, is more satisfactory than deﬁnitions found in the recent literature, and that allows statistically signiﬁcant and economically relevant predictions of cross-sectional excess returns. Our value pricing factor exploits the differences between the market and the theoretical values of Treasury bonds, where the theoretical value is assessed using an economically-justiﬁable Gaussian dynamic term structure model.
We show that the proﬁtability of the strategy we build using our value signal is closely linked to Treasury market volatility, and we provide an explanation for this strong link using arguments similar to those that can be found in the recent literature on liquidity in Treasuries.
|Research Cluster :||Finance|