Time-Varying Duration and the Value Factor Correlation with Interest Rates
Executive Summary
The inconsistent relationship between value factor returns and changes in interest rates, strong in recent years but mixed historically, can be explained by the time-varying duration of a portfolio that is long cheap stocks and short expensive stocks.
- In a simple model, holding all else equal, low government bond yields cause the duration of expensive stocks to increase by more than that of cheaper stocks.
- This change in duration increases the sensitivity of the portfolio to changes in interest rates.
- A period of higher interest rates may see a moderation in the recent heightened sensitivity of the value factor to movements in interest rates.
