TL;DR
Factor premiums are the additional returns that investors earn by taking on specific risk factors. For instance, a stock with high market risk should offer investors a 3-5% higher return to compensate for the risk premium.
9 min readIf factor investing works, why doesn't everyone do it? The answer lies in what drives factor premia. Two main schools of thought exist: risk-based and behavioral.
Risk-Based Explanation
According to Fama and French, the value premium exists because cheap stocks are genuinely riskier — higher financial distress risk and bankruptcy probability. Investors earn extra return (premium) for bearing this risk. Under this view, there's no free lunch; factor returns are risk compensation.
Behavioral Explanation
For momentum, behavioral explanations are stronger. Investors react slowly to news (underreaction), feed trends through herding, and anchor to old prices. These systematic errors cause momentum signals to persist.
Structural Explanation
The low-volatility anomaly has structural causes: institutional investors are benchmark-constrained and cannot use leverage, so they ignore low-vol stocks. Retail investors prefer lottery-like high-vol stocks. This supply-demand imbalance sustains the low-vol premium.
Factor Premia on BIST
Turkey's market has high retail investor share, limited analyst coverage, and elevated macro volatility. These conditions amplify behavioral errors and strengthen factor premia. 10-year BIST backtest results support global academic findings.
Related articles: What Is Factor Investing?, Momentum Factor, Value Factor, Low Volatility.
Frequently Asked Questions
What are factor premiums?
Factor premiums refer to the additional returns that investors earn by taking on specific risk factors. For example, stocks with high growth potential in the BIST 100 index offer investors the opportunity to benefit from the growth factor premium.
How is factor investing done?
Factor investing involves selecting assets based on specific risk factors. Investors aim to diversify their portfolios according to factors such as growth, value, and momentum to achieve higher returns.
How are factor premiums calculated?
Factor premiums are calculated as the additional return that comes from exposure to a specific risk factor. For instance, the return of a stock with market risk is determined by adding it to the overall market return.
Why are factor premiums important?
Factor premiums help investors optimize their long-term returns. For example, the additional returns obtained by investing in risky assets shape investment strategies.
How are factor premiums valid in the BIST?
In the BIST, factor premiums affect the performance of stocks based on risk factors such as value and growth. For example, stocks like THYAO and GARAN may offer different premiums influenced by these factors.
This content does not constitute investment advice. Past performance is not a guarantee of future results. Make your investment decisions based on your own risk profile.
