Risks of sector rotation strategies

Global factors are playing an increasingly important role in the pricing of securities. It is a new challenge to identify, the sources of those global factors and to structure portfolios that exploit the reward-to-risk opportunities from variation in these factors. The authors build on research suggesting that industry factors capture an economically important component of the variation in security returns. postulating a risk model that explicitly accounts for regional sector rotation decisions, they find that sensitivities to foreign factors are positively associated with the extent of firms' foreign sales activities. This provides empirical support for a reduced-form structural model, and it suggests that foreign sales data can be used as a conditioning variable to obtain economically sensible risk factor sensitivities.