The Factor Model Failure Puzzle

132 Pages Posted: 23 Nov 2021 Last revised: 22 Dec 2022

See all articles by Fahiz Baba Yara

Fahiz Baba Yara

Indiana University - Kelley School of Business

Brian H. Boyer

Brigham Young University - J. Willard and Alice S. Marriott School of Management

Carter Davis

Kelley School of Business, Indiana University

Date Written: November 19, 2021

Abstract

After six decades of research work, we still do not have a factor model that can price the cross section of U.S. equities. We empirically show that the most recent, cutting-edge asset pricing models developed to date using economic theory and machine learning cannot explain the average returns of the implied mean-variance efficient portfolios of other models. We create a theoretical model that suggests we may need hundreds of years of additional data to develop a factor model that can price the cross section.

Keywords: asset pricing, machine learning, factor models, stochastic discount factors, mean-variance efficiency, random forests, neural networks, prediction, Sharpe ratio optimization

JEL Classification: G10, G12

Suggested Citation

Baba Yara, Fahiz and Boyer, Brian H. and Davis, Carter, The Factor Model Failure Puzzle (November 19, 2021). Available at SSRN: https://ssrn.com/abstract=3967588 or http://dx.doi.org/10.2139/ssrn.3967588

Fahiz Baba Yara

Indiana University - Kelley School of Business ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

HOME PAGE: http://www.babayara.com

Brian H. Boyer

Brigham Young University - J. Willard and Alice S. Marriott School of Management ( email )

Provo, UT 84602
United States

Carter Davis (Contact Author)

Kelley School of Business, Indiana University ( email )

1309 E. 10th St.
Bloomington, IN 47405
United States

HOME PAGE: http://https://sites.google.com/site/carterkentdavis/

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