Risk Factor Centrality and the Cross-Section of Expected Returns

51 Pages Posted: 2 Nov 2020 Last revised: 21 Jan 2021

See all articles by Fernando Moraes

Fernando Moraes

Insper

Rodrigo De-Losso

University of São Paulo (USP) - Department of Economics

Date Written: January 20, 2021

Abstract

The Factor Zoo phenomenon calls for answers as to which risk factors are in fact capable of providing independent information on the cross-section of expected excess returns, while considering that asset-pricing literature has produced hundreds of candidates. Supported by the network analysis framework, our paper proposes a methodology that enables to select the elements that best summarize the information from the risk factor covariance matrix and investigate whether it is capable of explaining cross-section returns. Our findings lead to sparser models when compared to other factor zoo-related methodologies and, additionally, present equivalent in and out-of-sample R^2 results when confronted with those factor zoo models.

Keywords: Risk factors, factor zoo, graph lasso, network analysis

JEL Classification: G12, C55, D85

Suggested Citation

Tassinari Moraes, Fernando and De-Losso, Rodrigo, Risk Factor Centrality and the Cross-Section of Expected Returns (January 20, 2021). Available at SSRN: https://ssrn.com/abstract=3691331 or http://dx.doi.org/10.2139/ssrn.3691331

Fernando Tassinari Moraes (Contact Author)

Insper ( email )

R Quata 300
Sao Paulo, 04542-030
Brazil

Rodrigo De-Losso

University of São Paulo (USP) - Department of Economics ( email )

Av. Prof. Luciano Gualberto 908
Sao Paulo SP, 05508-010
Brazil
551130930957 (Phone)

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