When Factors Don't Span Their Basis Portfolios

Posted: 5 Jun 2016 Last revised: 2 Feb 2019

See all articles by Mark Grinblatt

Mark Grinblatt

University of California, Los Angeles (UCLA) - Finance Area; Yale University - International Center for Finance; National Bureau of Economic Research (NBER)

Konark Saxena

University of New South Wales

Date Written: June 2, 2016

Abstract

To price assets with a parsimonious set of factor mimicking portfolios, one typically identifies and weights well-diversified basis portfolios. Traditional weightings lead to factor mimicking portfolios that are unlikely to price even the basis portfolios they are formed from. We offer a method to combine basis portfolios into a single factor mimicking portfolio that is closely linked to the optimal portfolio. In practice, this method improves the pricing accuracy of parsimonious factor models, even for anomaly portfolios formed from characteristics that are distinct from those underlying the basis portfolios.

Keywords: Factor Models, Mean Variance Efficient Portfolios, Jackknife Estimators, HML, SMB

JEL Classification: G12, G14

Suggested Citation

Grinblatt, Mark and Saxena, Konark, When Factors Don't Span Their Basis Portfolios (June 2, 2016). Journal of Financial and Quantitative Analysis, 2018. Available at SSRN: https://ssrn.com/abstract=2788387 or http://dx.doi.org/10.2139/ssrn.2788387

Mark Grinblatt

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-1098 (Phone)
310-206-5455 (Fax)

Yale University - International Center for Finance

Box 208200
New Haven, CT 06520-8200
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Konark Saxena (Contact Author)

University of New South Wales ( email )

School of Banking and Finance
Australian School of Business
Sydney, NSW 2052
Australia

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