When Equity Factors Drop Their Shorts
30 Pages Posted: 26 Nov 2019
Date Written: November 27, 2019
This paper makes a breakdown of common equity factor strategies into their long and short legs, and finds that (i) most added value tends to come from the long legs, (ii) the long legs of factors offer more diversification than the short legs, and (iii) the performance of the shorts is generally subsumed by the longs. These results hold across large and small caps, are robust over time, carry over to international equity markets, and cannot be attributed to differences in tail risk. Moreover, we do not even account for the substantially higher implementation costs involved with the shorts compared to the longs. We also challenge recent claims that the value and low-risk factors are subsumed by the new Fama-French factors, as we find that this result is entirely driven by the short legs of these factors and breaks down for the longs. Altogether, our findings show that decomposing factors into their long and short dimensions is crucial for understanding factor premiums and building efficient factor portfolios.
Keywords: asset pricing, factor premiums, factor investing, short selling, limits to arbitrage, low volatility, size, value, momentum, profitability, investment, quality
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation