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Dissecting Characteristics Nonparametrically

66 Pages Posted: 11 Aug 2016 Last revised: 7 Mar 2017

Joachim Freyberger

University of Wisconsin - Madison

Andreas Neuhierl

University of Notre Dame - Department of Finance

Michael Weber

University of Chicago - Finance

Multiple version iconThere are 3 versions of this paper

Date Written: February 6, 2017

Abstract

We propose a nonparametric method to test which characteristics provide independent information for the cross section of expected returns. We use the adaptive group LASSO to select characteristics and to estimate how they affect expected returns nonparametrically. Our method can handle a large number of characteristics, allows for a flexible functional form, and is insensitive to outliers. Many of the previously identified return predictors do not provide incremental information for expected returns, and nonlinearities are important. Our proposed method has higher out-of-sample explanatory power compared to linear panel regressions, and increases Sharpe ratios by 50%.

Keywords: Cross Section of Returns, Anomalies, Expected Returns, Model Selection

JEL Classification: C14, C52, C58, G12

Suggested Citation

Freyberger, Joachim and Neuhierl, Andreas and Weber, Michael, Dissecting Characteristics Nonparametrically (February 6, 2017). Available at SSRN: https://ssrn.com/abstract=2820700 or http://dx.doi.org/10.2139/ssrn.2820700

Joachim Freyberger

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

Andreas Neuhierl

University of Notre Dame - Department of Finance ( email )

P.O. Box 399
Notre Dame, IN 46556-0399
United States

Michael Weber (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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