Factoring Characteristics into Returns: A Clinical Approach to Fama-French Portfolio Decomposition

58 Pages Posted: 29 May 2018 Last revised: 25 Jun 2018

See all articles by Marie Lambert

Marie Lambert

University of Liege - HEC Management School

Boris Fays

University of Liege, HEC Management School

Georges Hübner

HEC Liège

Date Written: June 20, 2018

Abstract

This paper demonstrates the biases introduced by unequal allocation of stocks into portfolios when building risk factors under the framework of an independent sort. We show further that these biases make a significant difference in producing mean-variance efficient portfolios. The biases induced by an independent and asymmetric sorting on-NYSE breakpoints can become very severe in specific market conditions. Mean-variance factor efficiency proves to be highly sensitive to the number of stocks into portfolios, which itself depends on the economic context. Our quasi-clinical investigation examines three methodological choices that have an impact on portfolio diversification: the (in)dependence and the (a)symmetry of the stock sorting procedure, and the sorting breakpoints. To minimize biases coming from unpriced risks, the optimal combination of these methodological criteria is unambiguously a sequential sort that starts with the control variables (pre-conditioning) with whole sample breakpoints.

Keywords: asset pricing, characteristics, attribute-matched portfolios, size, value

JEL Classification: G10, G11, G12

Suggested Citation

Lambert, Marie and Fays, Boris and Hübner, Georges, Factoring Characteristics into Returns: A Clinical Approach to Fama-French Portfolio Decomposition (June 20, 2018). Available at SSRN: https://ssrn.com/abstract=3179655 or http://dx.doi.org/10.2139/ssrn.3179655

Marie Lambert (Contact Author)

University of Liege - HEC Management School ( email )

HEC-Liège
rue Louvrex 14
LIEGE, Liege 4000
Belgium

Boris Fays

University of Liege, HEC Management School ( email )

Liège
Belgium

Georges Hübner

HEC Liège ( email )

Rue Louvrex 14, Bldg. N1
Liege, 4000
Belgium
+32 42327428 (Phone)

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