Characteristic-sorted portfolios and macroeconomic risks—An orthogonal decomposition

Abstract

We assess the relative importance of individual macroeconomic variables in explaining the time series variation of a broad range of characteristic-sorted portfolios. Employing an optimal orthogonalization approach, the explained variation in each characteristic-sorted portfolio is decomposed into components associated with individual macroeconomic variables. When examined unconditionally, the set of macroeconomic variables account for only limited explained variation. This low explained variation is partially resolved by allowing for dynamic and non-linear macroeconomic exposure. Finally, we highlight a degree of commonality in the explained macroeconomic variation associated with various characteristic-sorted portfolios, indicating that they proxy for particular macroeconomic characteristics simultaneously. • Assess links between characteristic-sorted portfolios and macroeconomic variables. • Focus on explained variation using an optimal variable orthogonalization approach. • Macroeconomic variables account for limited explained variation unconditionally. • Provide evidence for pronounced dynamics in macroeconomic exposure attributions. • Highlight a degree of commonality in the explained macroeconomic variation.