Time-varying factor premia in Nordic equities market

Abstract

Factor premia is a reward for taking on all of the risk in Nordic capital markets. Many important characteristics of factor investing have already been established, such as the significance of factor timing and existence of global factor premia in multiple asset classes. However, the reasons for time variation of factor excess returns, are poorly understood. Therefore, the aim of this thesis is to determine whether the performance of the selected factors is consistent across Nordic stock markets and time, as well as which variables may be explaining the time-varying performance differences in factor performance.

In this thesis it is explored whether factor diversification is more beneficial than country diversification. In addition, one of this thesis’ research sections examines the commonalities between factors and uses the return dispersion to assess potential correlations between them. This way it is possible to see, how market integration has developed through time and which factors show more similarities in performance between Nordic countries. The study uses factor excess returns as a metric to calculate whether the factors have been significant in the Nordic stock market. The findings of this study are useful for investors who want to gain a better understanding of the Nordic stock market’s dynamics and variables that explain higher returns on specific investing strategies.

During the study period, the results show that betting against beta, momentum, and quality factor strategies produced excess returns in the Nordics. All factor premia are cyclical, but momentum is the most stable over time producing consistent positive returns. The cross-section of factor excess returns does not appear to be explained by macroeconomic variables. The only variables that can be generalized to have an impact in the Nordics are real exchange rates, interest rate environment, and VIX. Market integration between Nordic countries is found to increase during good times, while market integration decreases during bad times. Factor diversification also outperforms country diversification by a significant margin.