Asset Pricing vs Asset Expected Returning in Factor-Portfolio Models

IGIER Working Paper No. 651

59 Pages Posted: 12 Jul 2019 Last revised: 24 Mar 2020

See all articles by Carlo A. Favero

Carlo A. Favero

Bocconi University - Department of Finance; Centre for Economic Policy Research (CEPR)

Alessandro Melone

Vienna Graduate School of Finance (VGSF)

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick

Multiple version iconThere are 2 versions of this paper

Date Written: July 11, 2019

Abstract

Standard factor-portfolio models focus on returns and leave prices undetermined. This approach ignores information contained in the time-series of asset prices, relevant for long-term investors and for detecting potential mis-pricing. To address this issue, we provide a new (co-)integrated methodology to factor modeling based on both prices and returns. Given a long-run relationship between the value of buy-and-hold portfolios in test assets and factors, we argue that a term-naturally labeled as Equilibrium Correction Term (ECT)-should be included when regressing returns on factors. We also propose to validate factor models by the existence of such a term. Empirically, we show that the ECT predicts equity returns, both in-sample and out-of-sample.

Keywords: Long-Horizon Returns, Predictability, Mispricing, Factor Models, Equilibrium Correction Term

JEL Classification: C38, G11, G17

Suggested Citation

Favero, Carlo A. and Melone, Alessandro and Tamoni, Andrea, Asset Pricing vs Asset Expected Returning in Factor-Portfolio Models (July 11, 2019). IGIER Working Paper No. 651. Available at SSRN: https://ssrn.com/abstract=3418352 or http://dx.doi.org/10.2139/ssrn.3418352

Carlo A. Favero (Contact Author)

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

HOME PAGE: http://www.igier.unibocconi.it\favero

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Alessandro Melone

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Vienna, 1020
Austria

Andrea Tamoni

Rutgers, The State University of New Jersey - Rutgers Business School at Newark & New Brunswick ( email )

1 Washington Park
Newark, NJ 07102
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
144
Abstract Views
623
rank
214,601
PlumX Metrics