Time-Series Efficient Factors

61 Pages Posted: 1 Apr 2020 Last revised: 2 Sep 2022

See all articles by Sina Ehsani

Sina Ehsani

Northern Illinois University

Juhani T. Linnainmaa

Dartmouth College - Tuck School of Business; National Bureau of Economic Research (NBER)

Date Written: September 2, 2022

Abstract

Factors in prominent asset pricing models are unconditionally minimum-variance inefficient: their returns are positively autocorrelated while risks, conditional on past returns, are constant. We derive a transformation that turns an autocorrelated factor into a "time-series efficient" factor. Time-series efficient factors span and earn 40% higher Sharpe ratios than the original factors. Momentum strategies' profits relate to factor inefficiency. Whereas the standard five-factor model does nothing to the momentum factor, the time-series efficient five-factor model subsumes it. We show that the leading macro-finance models generate factors that bear little resemblance to the real-life factors.

Keywords: Factors, Asset Pricing Models, Anomalies, Momentum, Risk-Return Tradeoff

JEL Classification: G11, G12, G40

Suggested Citation

Ehsani, Sina and Linnainmaa, Juhani T., Time-Series Efficient Factors (September 2, 2022). Tuck School of Business Working Paper No. 3555473, Available at SSRN: https://ssrn.com/abstract=3555473 or http://dx.doi.org/10.2139/ssrn.3555473

Sina Ehsani (Contact Author)

Northern Illinois University ( email )

Chicago, IL 60115
United States

Juhani T. Linnainmaa

Dartmouth College - Tuck School of Business ( email )

Hanover, NH 03755
United States

HOME PAGE: http://www.tuck.dartmouth.edu/faculty/faculty-directory/juhani-linnainmaa

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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