Factor Glut in Asset Pricing through a Modern Optimization Lens

48 Pages Posted: 6 Jun 2023

See all articles by Gurdip Bakshi

Gurdip Bakshi

Temple University - Fox School of Business and Management; Fox School of Business

Timothy Christensen

New York University (NYU) - Department of Economics

John Crosby

University of Maryland - Robert H. Smith School of Business

Xiaohui Gao

Fox School of Business, Temple University

Date Written: June 1, 2023

Abstract

This paper addresses questions regarding the dimensionality of the stochastic discount factor and the selection of the best factors that enter it. We analyze these questions theoretically and empirically with a novel methodology which performs both (i) estimation of factor loadings and (ii) best subset selection of factors in a single step via Mixed-Integer Linear Programming. We empirically illustrate how our approach eliminates worthless factors. Further, we rigorously justify our approach with formal statistical guarantees. Our methodology identifies the best five factors as (i) market, (ii) conservative minus aggressive, (iii) betting against beta, (iv) long-term reversal, and (v) leverage.

Keywords: Asset Pricing, Factor Models, Stochastic Discount Factor, Model Selection, Manhattan Distance, Mixed-Integer Optimization

JEL Classification: C01, C02, G10, G12, C13, C22, G13

Suggested Citation

Bakshi, Gurdip S. and Bakshi, Gurdip S. and Christensen, Timothy and Crosby, John and Gao, Xiaohui, Factor Glut in Asset Pricing through a Modern Optimization Lens (June 1, 2023). Available at SSRN: https://ssrn.com/abstract=4470335 or http://dx.doi.org/10.2139/ssrn.4470335

Gurdip S. Bakshi

Temple University - Fox School of Business and Management ( email )

Philadelphia, PA 19122
United States

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Fox School of Business ( email )

Department of Finance
Philadelphia, PA 19022
United States
215-204-6117 (Phone)
tuk40718@temple.edu (Fax)

HOME PAGE: http://https://sites.google.com/view/gurdipbakshi1

Timothy Christensen

New York University (NYU) - Department of Economics ( email )

269 Mercer Street, 7th Floor
New York, NY 10011
United States

John Crosby (Contact Author)

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
+447979901892 (Phone)

HOME PAGE: http://www.john-crosby.co.uk/

Xiaohui Gao

Fox School of Business, Temple University ( email )

Alter Hall 421
Philadelphia, PA 19122
United States

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

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