WHY is it so..
That, In a macroeconomic factor model, the factors are surprises in macroeconomic variables that significantly explain returns. Factor sensitivities are generally specified first in fundamental factor models, whereas factor sensitivities are estimated last in macroeconomic factor models.
Hi Jai. Let me try to explain.
Fundamental factor models are those which show the impact of assets’s returns due to change in fundamental factors of a company. Some of the common fundamental factors are- Dividend yield, P/E ratio, Earnings growth etc. These factors can usually be known and identified earlier and are assumed to be fixed. This means through various past research and studies, we can estimate their impact on the asset returns. Thus, factor sensitivities are calculated first in fundamental factor models as the factor sensitivities can be calculated and measured beforehand due to the factors being known earlier.
The macroeconomic factor model shows the impact on asset’s return due to change in various macroeconomic factors like Inflation, GDP growth, interest rate etc. The impact of these factors are generally not known beforehand. These factors are usually unexpected or are surprises to the economy. So, first this model quantifies and identifies these surprises or factors and based on these surprises, the factor sensitivities are then calculated.
To summarise, the factors are already known in fundamental factor models and therefore factor sensitivities can be specified first whereas in macroeconomic factor models, the factors are not known beforehand and therefore cannot he specified first. These factors need to be studied and estimated first and then when these factors are identified, we calculate the factor sensitivities afterwards.