Qihui Chen, Nikolai Roussanov, Xiaoliang Wang
arXiv 14 Dec 2021 · Econometrics
arXiv:2112.07121 · PDF · DOI · OpenAlex · Extracted main text
We introduce a simple and tractable methodology for estimating semiparametric conditional latent factor models. Our approach disentangles the roles of characteristics in capturing factor betas of asset returns from “alpha.” We construct factors by extracting principal components from Fama-MacBeth managed portfolios. Applying this methodology to the cross-section of U.S. individual stock returns, we find compelling evidence of substantial nonzero pricing errors, even though our factors demonstrate superior performance in standard asset pricing tests. Unexplained “arbitrage” portfolios earn high Sharpe ratios, which decline over time. Combining factors with these orthogonal portfolios produces out-of-sample Sharpe ratios exceeding 4.
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The works this paper leans on most, across its whole bibliography — not restricted to papers in our corpus. Ranked by composite intensity, which combines how often a work is mentioned, how many sections mention it, and how much of that falls in the main text rather than the appendix.
| Reference | Intensity | Mentions | Sections | Main text | |
|---|---|---|---|---|---|
| 1 | Kelly, B. T., S. Pruitt, and Y. Su (2019) Characteristics are covariances: A unified model of risk and return | 0.977 | 15 | 4 | 93% |
| 2 | Kozak, S., S. Nagel, and S. Santosh (2018) Interpreting factor models | 0.928 | 4 | 4 | 100% |
| 3 | Fama, E. F. and K. R. French (2015) A five-factor asset pricing model | 0.909 | 8 | 3 | 75% |
| 4 | Kim, S., R. A. Korajczyk, and A. Neuhierl (2020) Arbitrage portfolios | 0.843 | 4 | 3 | 75% |
| 5 | Fama, E. F. and K. R. French (2020) Comparing cross-section and time-series factor models | 0.811 | 4 | 2 | 100% |
| 6 | Fama, E. F. and K. R. French (1993) Common risk factors in the returns on stocks and bonds | 0.811 | 4 | 2 | 100% |
| 7 | Hoberg, G. and I. Welch (2009) Optimized vs | 0.811 | 4 | 2 | 100% |
| 8 | Kirby, C (2020) Firm characteristics, cross-sectional regression estimates, and asset pricing tests | 0.811 | 4 | 2 | 100% |
| 9 | Fan, J., Y. Liao, and W. Wang (2016) a): Projected principal component analysis in factor models | 0.769 | 11 | 4 | 45% |
| 10 | Freyberger, J., A. Neuhierl, and M. Weber (2020) Dissecting characteristics nonparametrically | 0.737 | 3 | 2 | 100% |
Showing the top 10 of 77 scored citations.