Comparing Factor Models with Price-Impact Costs

66 Pages Posted: 30 Oct 2020 Last revised: 16 May 2022

See all articles by Sicong (Allen) Li

Sicong (Allen) Li

London Business School

Victor DeMiguel

London Business School

Alberto Martin-Utrera

Iowa State University

Date Written: August 15, 2020

Abstract

The Sharpe-ratio criterion proposed by Barillas and Shanken (2017) to compare factor models is insufficient in the presence of price-impact costs because the efficient frontier spanned by the factors is nonlinear. Instead, we propose a statistical test to compare factor models in terms of mean-variance utility net of price-impact costs. Empirically, model performance depends not only on the turnover required to rebalance the factor portfolios, but also on the liquidity of the stocks traded and the absolute risk-aversion parameter. The q-factor model, the six-factor Fama-French model, and a high-dimensional model outperform for high, medium and low absolute risk aversion, respectively.

Keywords: trading costs, mean-variance utility, statistical test.

JEL Classification: G11, G12

Suggested Citation

Li, Sicong (Allen) and DeMiguel, Victor and Martin-Utrera, Alberto, Comparing Factor Models with Price-Impact Costs (August 15, 2020). Available at SSRN: https://ssrn.com/abstract=3688484 or http://dx.doi.org/10.2139/ssrn.3688484

Sicong (Allen) Li (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Victor DeMiguel

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Alberto Martin-Utrera

Iowa State University ( email )

613 Wallace Road
Ames, IA 50011-2063
United States

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