Winners from Winners: A Tale of Risk Factors
43 Pages Posted: 17 Nov 2019 Last revised: 18 Sep 2021
Date Written: June 30, 2021
Starting from the twelve distinct risk factors in four well-established asset pricing models, a pool we refer to as the winners, we construct and compare 4,095 asset pricing models and find that the model with the risk factors, Mkt, SMB, MOM, ROE, MGMT, and PEAD, performs the best in terms of Bayesian posterior probability, out-of-sample predictability, and Sharpe ratio. A more extensive model comparison of 8,388,607 models, constructed from the twelve winners plus eleven principal components of anomalies unexplained by the winners, shows the benefit of incorporating information in genuine anomalies in explaining the cross-section of expected equity returns.
Keywords: Model comparison, Factor models, Anomaly, Discount factor, Portfolio analysis
JEL Classification: G12, C11, C12, C52, C58
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