Arbitrage Portfolios

Review of Financial Studies, Forthcoming

96 Pages Posted: 31 Oct 2018 Last revised: 18 May 2020

See all articles by Soohun Kim

Soohun Kim

College of Business, Korea Advanced Institute of Science and Technology (KAIST)

Robert A. Korajczyk

Northwestern University

Andreas Neuhierl

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

Date Written: April 9, 2020

Abstract

We propose new methodology to estimate arbitrage portfolios by utilizing information contained in firm characteristics for both abnormal returns and factor loadings. The methodology gives maximal weight to risk-based interpretations of characteristics' predictive power before any attribution to abnormal returns. We apply the methodology in simulated factor economies and to a large panel of U.S. stock returns from 1965–2018. The methodology works well in simulation and when applied to U.S. stocks. Empirically, we find the arbitrage portfolio has (statistically and economically) significant alphas relative to several popular asset pricing models and annualized Sharpe ratios ranging from 1.31 to 1.66.

Keywords: Arbitrage, Alpha, Factor Model, Hedge, Principal Components

JEL Classification: G10, G11, G12

Suggested Citation

Kim, Soohun and Korajczyk, Robert A. and Neuhierl, Andreas, Arbitrage Portfolios (April 9, 2020). Review of Financial Studies, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3263001 or http://dx.doi.org/10.2139/ssrn.3263001

Soohun Kim

College of Business, Korea Advanced Institute of Science and Technology (KAIST) ( email )

85 Hoegiro Dongdaemun-Gu
Seoul 02455
Korea, Republic of (South Korea)

Robert A. Korajczyk

Northwestern University ( email )

Kellogg School of Management
2211 Campus Drive, Room 4357
Evanston, IL 60208-0898
United States
847-491-8336 (Phone)
847-491-7781 (Fax)

HOME PAGE: http://www.kellogg.northwestern.edu/faculty/directory/korajczyk_robert.aspx#research

Andreas Neuhierl (Contact Author)

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

St. Louis, MO
United States

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