Firm Characteristics and Expected Stock Returns

59 Pages Posted: 13 Jun 2018 Last revised: 9 Jul 2020

See all articles by Yufeng Han

Yufeng Han

University of North Carolina (UNC) at Charlotte - Finance

Ai He

University of South Carolina - Darla Moore School of Business

David Rapach

Saint Louis University; Washington University in St. Louis

Guofu Zhou

Washington University in St. Louis - John M. Olin Business School; China Academy of Financial Research (CAFR)

Date Written: July 8, 2020

Abstract

We analyze the joint out-of-sample predictive ability of a comprehensive set of 299 firm characteristics for cross-sectional stock returns. We develop a cross-sectional out-of-sample R2 statistic that provides an informative measure of the accuracy of cross-sectional return forecasts in terms of mean squared forecast error. To improve cross-sectional return forecasts based on a large number of firm characteristics, we propose an E-LASSO approach that implements shrinkage in a flexible manner. Our new approach produces significant cross-sectional out-of-sample R2 gains on a consistent basis over time and provides the most accurate out-of-sample estimates of cross-sectional expected returns to date. The E-LASSO approach also generates substantial economic value in the context of long-short portfolios. Finally, we present evidence that more characteristics work better than fewer with respect to forecasting cross-sectional stock returns.

Keywords: Cross-sectional expected stock returns, Characteristic premia, Shrinkage, LASSO, Forecast combination, Forecast encompassing

JEL Classification: C53, C55, C58, G11, G14, G17

Suggested Citation

Han, Yufeng and He, Ai and Rapach, David and Zhou, Guofu, Firm Characteristics and Expected Stock Returns (July 8, 2020). Available at SSRN: https://ssrn.com/abstract=3185335 or http://dx.doi.org/10.2139/ssrn.3185335

Yufeng Han

University of North Carolina (UNC) at Charlotte - Finance ( email )

9201 University City Boulevard
Charlotte, NC 28223
United States

Ai He

University of South Carolina - Darla Moore School of Business ( email )

1014 Greene Street
Columbia, SC 29208
United States

HOME PAGE: http://www.aihefinance.com/

David Rapach

Saint Louis University ( email )

3674 Lindell Blvd
St. Louis, MO 63108-3397
United States

HOME PAGE: http://https://sites.google.com/slu.edu/daverapach

Washington University in St. Louis

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

HOME PAGE: http://https://sites.google.com/slu.edu/daverapach

Guofu Zhou (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

Washington University
Campus Box 1133
St. Louis, MO 63130-4899
United States
314-935-6384 (Phone)
314-658-6359 (Fax)

HOME PAGE: http://apps.olin.wustl.edu/faculty/zhou/

China Academy of Financial Research (CAFR)

Shanghai Advanced Institute of Finance
Shanghai P.R.China, 200030
China

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