Multifactor Market Indexes
44 Pages Posted: 15 Dec 2017 Last revised: 11 Apr 2019
Date Written: April 10, 2019
A growing list of proposed factors is causing factor and model selection problems in asset pricing research and practice. This paper mitigates these problems by combining the CRSP market index with multiple factors to create a single multifactor market index. Empirical tests of multifactor market indexes using a variety of different test asset portfolios indicate that: (1) Sharpe ratios substantially increase and GRS test statistics decrease as multifactors are incrementally added to the CRSP index; and (2) the resultant multifactor market indexes are significantly priced in cross-sectional tests with t-values exceeding 3.0 in most cases. Further analyses create a new aggregate industry index which is priced among industry portfolios. When multifactors and industry portfolios are combined with the CRSP index, this more general multifactor market index boosts cross-sectional t-values and eliminates mispricing error. Lastly, momentum continues to be priced even when included in multifactor market indexes and therefore is a possible strong factor. Implications to developing more parsimonious asset pricing models as well as more efficient market indexes for investment purposes are discussed.
Keywords: efficient portfolios, market, beta, market index, multifactors
JEL Classification: G11, G12
Suggested Citation: Suggested Citation