New and Old Sorts: Implications for Asset Pricing
69 Pages Posted: 6 Mar 2020 Last revised: 12 Mar 2020
Date Written: January 31, 2020
We study the returns to characteristic-sorted portfolios up to five years after portfolio formation. Among a set of 56 characteristics, we find large pricing errors between the contemporaneous returns of new and old sorts, where new sorts use only the most recent observations of firm characteristics. These relative pricing errors are not captured by existing asset pricing models and have been overlooked by standard tests using only returns to new sorts. Thus, pricing errors across horizons provide new and powerful information to test asset pricing models. Further, we show that these pricing errors are strongly related to a characteristic's market beta and connected to the difference in return between new and old stocks in the characteristic-sorted portfolios. We argue that investors can improve the performance of characteristic-based strategies by considering past observations of firm characteristics.
Keywords: Characteristic-Based Return Predictability, Horizon, Pricing Errors, Tests of Asset Pricing Models, Factors
JEL Classification: G11, G12
Suggested Citation: Suggested Citation