The Low-Minus-High Portfolio and the Factor Zoo
43 Pages Posted: 7 May 2019 Last revised: 21 May 2019
Date Written: March 31, 2019
Anomalies in the cross section of returns should not be regarded as evidence against the CAPM. Regardless whether the CAPM is rejected for valid reasons or by mistake, a single long-short portfolio will always explain, together with the market, 100% of the cross-sectional variation in returns. Yet, this portfolio need not proxy for fundamental risk. We show theoretically how factors based on valuation ratios (e.g, book-to-market), or on investment rates, can be proxies for this portfolio. More generally, the empiricist can uncover an infinity of proxies for this portfolio, thus unleashing the factor zoo.
Keywords: CAPM, factor zoo, anomalies
JEL Classification: G12
Suggested Citation: Suggested Citation