Causality and Factor Investing: A Primer

Abstract

Factor investing is a foundational paradigm in quantitative asset management. Yet, despite the proliferation of factors and widespread institutional adoption, most strategies have failed to live up to their in-sample promise. While p-hacking and backtest overfitting have received considerable blame, a more insidious source of error is rarely discussed: the uncritical application of an econometric canon that ignores causal structure. This paper introduces the concept of the factor mirage—a factor model that appears statistically valid but is causally misspecified. We show how collider bias and confounder bias, when embedded in the standard regression framework, can yield misleading inferences, poor out-of-sample performance, and misguided investment decisions. By shifting from associational to causal reasoning, practitioners can build more robust strategies, reduce false discoveries, and restore trust in factor-based approaches.

Keywords: Causal inference, causal discovery, confounder, collider, factor investing, p-hacking, underperformance, systematic losses. JEL Classification: G0