Factor Construction Zoo: Are Factor Exposures Created Equal?

Journal of Portfolio Management, Forthcoming

1 Pages Posted: 29 Dec 2020 Last revised: 12 Aug 2022

Date Written: November 1, 2020


The answer is no. Investors hunt factor exposures and premium across the stock universe. However, the relation between factor exposures and returns is non-linear. Large-scale simulation shows that similar target factor exposures can be engineered using various portfolio construction methodologies, but the resulting portfolios exhibit significant dispersion in expected returns and comovement with the market and other factor funds. The dispersion increases with target factor exposures. As such, some factor exposures are more efficient than others. This paper further studies a comprehensive list of portfolio construction choices for value, momentum, and quality funds, discusses the tradeoff at work, and provides a framework for the assessment of factor exposure efficiency. It is important to account for non-linearity in constructing or evaluating factor funds.

Keywords: factor exposure, portfolio construction, risk, return, non-linearity

JEL Classification: G10, G11, G12

Suggested Citation

Zhang, Shaojun, Factor Construction Zoo: Are Factor Exposures Created Equal? (November 1, 2020). Journal of Portfolio Management, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3753616 or http://dx.doi.org/10.2139/ssrn.3753616

Shaojun Zhang (Contact Author)

The Ohio State University

2100 Neil Avenue
Columbus, OH 43210-1144
United States

HOME PAGE: http://sites.google.com/view/zhangshaojun

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