Optimized vs. Sort-Based Portfolios
University of Southern California - Marshall School of Business
University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)
December 10, 2009
AFA 2010 Atlanta Meetings Paper
Factors and test portfolios can be formed by optimizing objective functions instead of by sorting. Optimizing is more parsimonious and flexible, and the portfolio returns can be easier to find. Our approach effectively marries some advantages of the Fama and MacBeth (1973) cross-sectional approach with those of the time-series approach in Black, Jensen, and Scholes (1971). Our paper shows that optimized portfolios can make a difference: they reverse the inference in Daniel and Titman (1997) and Davis, Fama, and French (2000).
Number of Pages in PDF File: 45
Keywords: book-to-market, HML, characteristics, factors
JEL Classification: G1
Date posted: January 14, 2009 ; Last revised: December 28, 2009
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