Characteristic-Based Returns: Alpha or Smart Beta?

Journal of Investment Management, Forthcoming

KAIST College of Business Working Paper Series

32 Pages Posted: 24 Jul 2021

See all articles by Soohun Kim

Soohun Kim

College of Business, Korea Advanced Institute of Science and Technology (KAIST)

Robert A. Korajczyk

Northwestern University - Kellogg School of Management

Andreas Neuhierl

Washington University in St. Louis - John M. Olin Business School

Date Written: July 5, 2021

Abstract

Abstract We propose new methodology to construct arbitrage portfolios by utilizing information contained in firm characteristics for both abnormal returns and betas (and, therefore, smart-beta risk premiums). Our methodology gives maximal weight to risk-based interpretations of characteristics' predictive power before any attribution to abnormal returns. The method allows the explanatory power of a characteristic for both alpha and beta to ebb and flow. This feature is particularly important when we expect that profit opportunities may be arbitraged away by investors. We apply the methodology to a large panel of U.S. stock returns from 1965–2018. Empirically, characteristics have time-varying explanatory power for both factor betas and alpha. We find the arbitrage portfolio has (statistically and economically) significant alpha and annualized Sharpe ratios ranging from 1.31 to 1.66.

Keywords: arbitrage, characteristic based model, smart beta, factor pricing

JEL Classification: G12, C58, C38

Suggested Citation

Kim, Soohun and Korajczyk, Robert A. and Neuhierl, Andreas, Characteristic-Based Returns: Alpha or Smart Beta? (July 5, 2021). Journal of Investment Management, Forthcoming, KAIST College of Business Working Paper Series, Available at SSRN: https://ssrn.com/abstract=3880589

Soohun Kim

College of Business, Korea Advanced Institute of Science and Technology (KAIST) ( email )

85 Hoegiro Dongdaemun-Gu
Seoul 02455
Korea, Republic of (South Korea)

Robert A. Korajczyk (Contact Author)

Northwestern University - Kellogg School of Management ( email )

2211 Campus Drive, Room 4357
Evanston, IL 60208-0898
United States
847-491-8336 (Phone)
847-491-7781 (Fax)

HOME PAGE: http://www.kellogg.northwestern.edu/faculty/directory/korajczyk_robert.aspx#research

Andreas Neuhierl

Washington University in St. Louis - John M. Olin Business School ( email )

St. Louis, MO
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
165
Abstract Views
649
rank
229,234
PlumX Metrics