Where are the Factors in Factor Investing?

17 Pages Posted: 25 Jan 2023 Last revised: 10 Mar 2024

See all articles by Marcos Lopez de Prado

Marcos Lopez de Prado

Cornell University - Operations Research & Industrial Engineering; Abu Dhabi Investment Authority; True Positive Technologies

Date Written: January 29, 2023

Abstract

In this article, I advocate for the use of causal graphs to modernize the field of factor investing, and set it on a logically-coherent foundation. In order to do that, first I must introduce the concepts of association and causations. Second, I explain the use of causal graphs and the real (causal) meaning of the “ceteris paribus” assumption that is so popular among economists. Third, I explain how causal graphs help us estimate causal effects in observational (non-experimental) studies. Fourth, I illustrate all of the earlier concepts with Monte Carlo experiments. Fifth, I conclude that the field of factor investing must embrace causal graphs in order to wake up from its associational slumber.

Keywords: Association, causation, causal inference, causal discovery, causal mechanism, confounder, factor investing, backtest overfitting

JEL Classification: G0, G1, G2, G15, G24, E44

Suggested Citation

López de Prado, Marcos and López de Prado, Marcos, Where are the Factors in Factor Investing? (January 29, 2023). Available at SSRN: https://ssrn.com/abstract=4336002 or http://dx.doi.org/10.2139/ssrn.4336002

Marcos López de Prado (Contact Author)

Cornell University - Operations Research & Industrial Engineering ( email )

237 Rhodes Hall
Ithaca, NY 14853
United States

HOME PAGE: http://www.orie.cornell.edu

Abu Dhabi Investment Authority ( email )

211 Corniche Road
Abu Dhabi, Abu Dhabi PO Box3600
United Arab Emirates

HOME PAGE: http://www.adia.ae

True Positive Technologies ( email )

NY
United States

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

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