Firm Characteristics and Empirical Factor Models: A Model-Mining Experiment

Abstract

''A three-factor model using momentum and cashflow-to-price factors explains 14 asset pricing anomalies.'' Our model-mining experiment provides a backdrop to evaluate such claims. We construct three-factor linear pricing models that match return spreads associated with as many as 14 out of 27 commonly used firm characteristics over the 1971-2011 sample. 71% and 48% of the factor models match a larger fraction of target return cross-sections than the CAPM or Fama-French three-factor model, respectively. The relative performance of factor models is highly sensitive to sample choice and factor construction methodology. Simulation analysis indicates that the empirical performance across the mined models provides virtually no evidence in support of the underlying risk-return relations.

Keywords: Anomalies, Factor Models, Data-mining, Firm Characteristic

JEL Classification: G12