A Protocol for Factor Identification

Review of Financial Studies, Forthcoming

50 Pages Posted: 24 Jul 2017 Last revised: 17 Jun 2018

See all articles by Kuntara Pukthuanthong

Kuntara Pukthuanthong

University of Missouri, Columbia

Richard Roll

California Institute of Technology

Avanidhar Subrahmanyam

University of California, Los Angeles (UCLA) - Finance Area; Financial Research Network (FIRN)

Multiple version iconThere are 4 versions of this paper

Date Written: October 5, 2017

Abstract

We propose a protocol for identifying genuine risk factors. The underlying premise is that a risk factor must be related to the covariance matrix of returns, must be priced in the cross-section of returns, and should yield a reward-to-risk ratio that is reasonable enough to be consistent with risk pricing. A market factor, a profitability factor, and traded versions of macroeconomic factors pass our protocol, but many characteristic-based factors do not. Several of the underlying characteristics, however, do command premiums in the cross-section.

Keywords: Factors, Factor Identification, Principle Components, Cross-Sectional Regression, Return Variation, Error-In-Variable Problem

JEL Classification: G10, G11, G12

Suggested Citation

Pukthuanthong, Kuntara and Roll, Richard W. and Subrahmanyam, Avanidhar, A Protocol for Factor Identification (October 5, 2017). Review of Financial Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3005477 or http://dx.doi.org/10.2139/ssrn.3005477

Kuntara Pukthuanthong (Contact Author)

University of Missouri, Columbia ( email )

Robert J. Trulaske, Sr. College of Business
403 Cornell Hall
Columbia, MO 65211
United States
6198076124 (Phone)

HOME PAGE: https://www.kuntara.net/

Richard W. Roll

California Institute of Technology ( email )

1200 East California Blvd
Mail Code: 228-77
Pasadena, CA 91125
United States
626-395-3890 (Phone)
310-836-3532 (Fax)

Avanidhar Subrahmanyam

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

Los Angeles, CA 90095-1481
United States
310-825-5355 (Phone)
310-206-5455 (Fax)

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

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