Income Hedging, Dynamic Style Preferences, and Return Predictability

Research output: Contribution to journalArticle

Abstract

We propose a theoretical measure of income hedging demand and show that it affects asset prices. We focus on the value factor and first demonstrate that our demand estimates are correlated with the actual demands of retail and mutual fund investors. We then show that the aggregate high-minus-low (HML) demand predicts HML returns. Exploiting the state-level variation in income risk, we demonstrate that state-level hedging demands predict state-level HML returns. A long-short portfolio that exploits this hedging-induced predictability earns an annualized risk-adjusted return of 6%.

Original languageEnglish (US)
JournalJournal of Finance
DOIs
StatePublished - Jan 1 2019

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Hedging
Income
Return predictability
Dynamic hedging
Factors
Investors
Risk-adjusted returns
Mutual funds
Retail
Income risk
Asset prices
Predictability

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

Cite this

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title = "Income Hedging, Dynamic Style Preferences, and Return Predictability",
abstract = "We propose a theoretical measure of income hedging demand and show that it affects asset prices. We focus on the value factor and first demonstrate that our demand estimates are correlated with the actual demands of retail and mutual fund investors. We then show that the aggregate high-minus-low (HML) demand predicts HML returns. Exploiting the state-level variation in income risk, we demonstrate that state-level hedging demands predict state-level HML returns. A long-short portfolio that exploits this hedging-induced predictability earns an annualized risk-adjusted return of 6{\%}.",
author = "Addoum, {Jawad M.} and Stefanos Delikouras and George Korniotis and Alok Kumar",
year = "2019",
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journal = "Journal of Finance",
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AB - We propose a theoretical measure of income hedging demand and show that it affects asset prices. We focus on the value factor and first demonstrate that our demand estimates are correlated with the actual demands of retail and mutual fund investors. We then show that the aggregate high-minus-low (HML) demand predicts HML returns. Exploiting the state-level variation in income risk, we demonstrate that state-level hedging demands predict state-level HML returns. A long-short portfolio that exploits this hedging-induced predictability earns an annualized risk-adjusted return of 6%.

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