Factor Modeling: The Benefits of Disentangling Cross-Sectionally for Explaining Stock Returns

30 Pages Posted: 1 Oct 2020

See all articles by Bruce I. Jacobs, Ph.D.

Bruce I. Jacobs, Ph.D.

Jacobs Levy Equity Management

Kenneth N. Levy

Jacobs Levy Equity Management

Date Written: September 24, 2020

Abstract

More than three decades ago, Jacobs and Levy introduced in the Financial Analysts Journal the idea of disentangling returns across numerous factors via cross-sectional analysis, and examined the benefits of using the time-series of returns to disentangled factors for return forecasting. The disentangling approach has since been employed by several studies and implemented by a number of investment firms. Recently, Fama and French found that models using cross-sectional factors are better able to explain equity returns than models using time-series factors. This article revisits disentangling, critically compares the explanatory power of models that use cross-sectional factors with those that use time-series factors, and discusses the several benefits of the cross-sectional approach for investment management.

Keywords: Factor models, Factor returns, Cross-sectional models, Disentangling, Time-series models, Portfolio management, Stock returns, Equity characteristics

JEL Classification: G11, G12

Suggested Citation

Jacobs, Bruce I. and Levy, Kenneth N., Factor Modeling: The Benefits of Disentangling Cross-Sectionally for Explaining Stock Returns (September 24, 2020). Available at SSRN: https://ssrn.com/abstract=3698787 or http://dx.doi.org/10.2139/ssrn.3698787

Bruce I. Jacobs (Contact Author)

Jacobs Levy Equity Management ( email )

100 Campus Drive
P.O. Box 650
Florham Park, NJ 07932-0650
United States
973-410-9222 (Phone)
973-410-9333 (Fax)

HOME PAGE: https://jlem.com/who-we-are#/nav/founders

Kenneth N. Levy

Jacobs Levy Equity Management ( email )

100 Campus Drive
P.O. Box 650
Florham Park, NJ 07932-0650
United States
973-410-9222 (Phone)
973-410-9333 (Fax)

HOME PAGE: https://jlem.com/who-we-are#/nav/founders

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