Elephants and the Cross-Section of Expected Returns

37 Pages Posted: 21 Nov 2017 Last revised: 15 Mar 2019

See all articles by Nora Laurinaityte

Nora Laurinaityte

Goethe University Frankfurt, House of Finance (HoF), Graduate School of Economics, Finance and Management (GSEFM) ; Goethe University Frankfurt - Research Center SAFE

Christoph Meinerding

Deutsche Bundesbank

Christian Schlag

Goethe University Frankfurt - Research Center SAFE

Julian Thimme

Karlsruhe Institute of Technology

Date Written: March 11, 2019

Abstract

Standard GMM cross-sectional asset pricing tests are susceptible to a ``trade-off'': They can generate high explanatory power for factor models by allowing the estimated factor means to substantially deviate from the observed sample averages. In fact, by shifting the weights on the moment conditions, any level of cross-sectional fit can be attained. This property is a feature of the GMM estimation design and applies to weak as well as strong factors, and to all sample sizes and test assets. To quantify the trade-off, we run tests based on simulated and empirical data.

Keywords: Asset pricing, cross-section of expected returns, GMM, factor zoo

JEL Classification: G00, G12, C21, C13

Suggested Citation

Laurinaityte, Nora and Meinerding, Christoph and Schlag, Christian and Thimme, Julian, Elephants and the Cross-Section of Expected Returns (March 11, 2019). Available at SSRN: https://ssrn.com/abstract=3073197 or http://dx.doi.org/10.2139/ssrn.3073197

Nora Laurinaityte

Goethe University Frankfurt, House of Finance (HoF), Graduate School of Economics, Finance and Management (GSEFM) ( email )

Grüneburgplatz 1
Frankfurt
Germany

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Christoph Meinerding (Contact Author)

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

Christian Schlag

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany
+49 69 798 33699 (Phone)

Julian Thimme

Karlsruhe Institute of Technology ( email )

Kaiserstraße 12
Karlsruhe, Baden Württemberg 76131
Germany

HOME PAGE: http://julianthimme.de

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