Factor Loadings as Proxies for Equity Characteristics, Round 3

45 Pages Posted: 19 May 2016 Last revised: 29 May 2018

See all articles by Mike Dickson

Mike Dickson

University of North Carolina at Charlotte; Horizon Investments

Date Written: May 18, 2016


I provide a comprehensive analysis that indicates characteristic-based factor loadings provide reasonable proxies for equity fundamentals. My methodology relies on the equilibrium relationships between cross-sectional expected return regressions and time-series empirical asset pricing models. I compare the performance of portfolios formed by observed equity fundamentals and pre-formation factor loadings. My analysis shows that the portfolios formed by book-to-market factor loadings closely matches the empirical return distribution of portfolios formed by the book-to-market characteristic. However, for market equity, gross-profitability, and investment, only the top performing portfolios are well approximated by factor loadings. My results are enhanced when conducting the same analyses on portfolios of equities, meant to reduce estimation risk. Finally, a portfolio formed from aggregating the signals from multiple pre-formation factor loadings beat an equally-weighed benchmark by nearly 400 basis points a year, and earned a Sharpe ratio that was 20% larger.

Keywords: return predictability, factor models, asset pricing tests

JEL Classification: G11, G12, G17, C13

Suggested Citation

Dickson, Mike and Dickson, Mike, Factor Loadings as Proxies for Equity Characteristics, Round 3 (May 18, 2016). Available at SSRN: https://ssrn.com/abstract=2781623 or http://dx.doi.org/10.2139/ssrn.2781623

Mike Dickson (Contact Author)

Horizon Investments ( email )

Charlotte, NC
United States
7049193611 (Phone)
7049193611 (Fax)

HOME PAGE: http://www.horizoninvestments.com/

University of North Carolina at Charlotte ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

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