An Empirical Assessment of Characteristics and Optimal Portfolios
55 Pages Posted: 12 Apr 2018 Last revised: 30 Apr 2021
Date Written: January 26, 2018
We analyze characteristics' joint predictive information through the lens of out-of-sample power
utility functions. Linking weights to characteristics to form optimal portfolios suffers from estimation
error which we mitigate by maximizing an in-sample loss function that is more concave than
the utility function. While no single characteristic can be used to enhance utility by all investors,
conditioning on momentum, size, and residual volatility produces portfolios with significantly
higher certainty equivalents than benchmarks for all investors. Characteristic complementarities
produce the benefits, for example momentum mitigates overfitting inherent in other characteristics.
Optimal portfolios? returns lie largely outside the span of traditional factors.
Keywords: cross-section of stock returns; stock characteristics; optimal portfolios
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