Characteristics-Based Factors

Abstract

This study examines the pricing of characteristics-based factors using portfolios that are formed by sorting stocks based on their exposure to these factors. These beta-sorted portfolios have very large ex post factor beta spreads. However, the return spreads between high- and low-beta firms are typically tiny and insignificant. More important, we show that the differences between factor-adjusted returns and characteristics-adjusted returns for these beta-sorted portfolios are both economically and statistically significant at about 0.41% per month. Our results thus urge cautions
regarding the common practice of using factor models such as adjusting for investment style, performance evaluation, and performance attribution.

Keywords: Factor, Beta, Characteristics, Performance Evaluation, Anomalies

JEL Classification: G12