Anomaly or Risk Factor? A Stepwise Evaluation

48 Pages Posted: 20 Jul 2023 Last revised: 31 Jul 2023

See all articles by Guanhao Feng

Guanhao Feng

City University of Hong Kong (CityU)

Wei Lan

Southwestern University of Finance and Economics (SWUFE) - Statistical School and Center of Statistical Research

Hansheng Wang

Peking University - Guanghua School of Management

Jun Zhang

School of Statistics

Date Written: June 30, 2023

Abstract

In empirical asset pricing, traded candidate factors can be either on the left- or right-hand side of the factor model as an anomaly or true risk factor, because anomalies should be explained by the set of risk factors with zero intercepts --- pricing errors. This unsupervised factor selection is a new statistical problem that cannot be answered by existing model selection studies that rely on test assets. This paper proposes a stepwise evaluation framework that sequentially separates a small set of risk factors from a large number of anomalies, resulting in a robust selection of true factors without (or with) test assets. With the statistical guarantee of selection consistency, our method utilizes the asset pricing duality between the minimal GRS statistic and the maximal Sharpe ratio when approximating the stochastic discount factor. Empirically, we find that seven selected factors can explain the remaining cross section of anomalies, along with exceptional factor investment performance.

Keywords: anomalies, factor efficiency, stepwise selection, GRS test, model comparison, Sharpe ratio

Suggested Citation

Feng, Guanhao and Lan, Wei and Wang, Hansheng and Zhang, Jun, Anomaly or Risk Factor? A Stepwise Evaluation (June 30, 2023). Available at SSRN: https://ssrn.com/abstract=4502439 or http://dx.doi.org/10.2139/ssrn.4502439

Guanhao Feng (Contact Author)

City University of Hong Kong (CityU) ( email )

83 Tat Chee Avenue
Hong Kong

Wei Lan

Southwestern University of Finance and Economics (SWUFE) - Statistical School and Center of Statistical Research ( email )

Zhizhi Zone 236, 555 Liutai Avenue
Wenjiang District
Chengdu, Sichuan 611130
China

Hansheng Wang

Peking University - Guanghua School of Management ( email )

Peking University
Beijing, Beijing 100871
China

HOME PAGE: http://hansheng.gsm.pku.edu.cn

Jun Zhang

School of Statistics ( email )

Chengdu
China

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

Paper statistics

Downloads
222
Abstract Views
673
Rank
256,752
PlumX Metrics