Analysis of Fama-French factors across business cycles

This paper uses the information in time-series behavior of conditional correlation between Fama-French factor portfolios and state variables that define the investment opportunity set, vis-a-vis the contemporaneous phase of the business cycle and/or the expectations about the near term business conditions, to clarify the risk based explanations provided for the empirical pricing power of Fama-French factors SMB and HML. I confirm the previously established relationship between SMB and default spread, and HML and term spread and I support evidence for the relationship between SMB returns and asset distress risk using the evidence from predictable changes in return sensitivities to these portfolios. Specifically, I document that sensitivity to asset distress risk is higher during recessionary periods, among small-growth stocks. I also show that investor sentiment takes part in inflating the relation between SMB and innovations to default spread, and HML and innovations to term spread. I discover statistical evidence that term spread has a significant role in predicting SMB returns, if the upcoming period is a recession. Finally, I document time-variation in sensitivities to SMB and HML returns(betas), but also show that this variation in betas does not affect the time variation of the price of unit sensitivities to these factors