A Portfolio Perspective on the Multitude of Firm Characteristics
85 Pages Posted: 8 Feb 2017 Last revised: 10 Mar 2018
Date Written: March 8, 2018
We investigate how many characteristics matter jointly for an investor who cares not only about average returns but also about portfolio risk and transaction costs. Our main finding is that transaction costs significantly increase the dimension of the cross section of stock returns. While in the absence of transaction costs only a small number of characteristics--about six--are significant, in the presence of transaction costs this number _increases_ to 15. The explanation is that, as we show analytically and empirically, combining characteristics helps to substantially reduce transaction costs because the trades in the underlying stocks required to rebalance different characteristics net out. Our work demonstrates that transaction costs provide an economic rationale to consider a larger number of characteristics than that considered in prominent asset-pricing models.
Keywords: transaction costs, cross section of stock returns, trading diversification
JEL Classification: G11
Suggested Citation: Suggested Citation