Basis Assets

52 Pages Posted: 29 Nov 2003

See all articles by Dong-Hyun Ahn

Dong-Hyun Ahn

University of North Carolina at Chapel Hill

Jennifer S. Conrad

University of North Carolina Kenan-Flagler Business School

Robert F. Dittmar

University of Michigan, Stephen M. Ross School of Business

Date Written: March 14, 2003

Abstract

This paper proposes a new method to form basis assets with which to represent investors' opportunity sets and evaluate the goodness-of-fit of asset pricing models. We use return correlations to form a measure of distance between securities, as in Ormerod and Mounfield (2000), and use this distance measure to sort securities into portfolios. We compare the inferences drawn from this set of basis assets with those drawn from other benchmark portfolios commonly used in the literature such as beta and size-sorted portfolios and the Fama and French (1993) size and book-to-market sorted portfolios. Specifically, we compare the results of spanning tests, tests of asset pricing models and inferences about optimal portfolios. The results suggest that the set of basis assets formed by clustering on historical correlations in returns does at least as well as characteristic-based portfolios at generating a proxy for an investor's opportunity set. The proposed set of portfolios also appears capable of generating measures of risk-return trade-off that are estimated with lower error. Finally, we compare the cluster portfolios to principal components extracted from the same sample period, and find that the cluster portfolios generate slightly higher out-of-sample dispersion in mean returns, a slightly lower Sharpe ratio and more stable weights on individual securities.

JEL Classification: G10,G11,G12

Suggested Citation

Ahn, Dong-Hyun and Conrad, Jennifer S. and Dittmar, Robert F., Basis Assets (March 14, 2003). AFA 2004 San Diego Meetings; Fifteenth Annual Utah Winter Finance Conference. Available at SSRN: https://ssrn.com/abstract=472227 or http://dx.doi.org/10.2139/ssrn.472227

Dong-Hyun Ahn

University of North Carolina at Chapel Hill ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States
919-962-3203 (Phone)
919-962-2068 (Fax)

Jennifer S. Conrad (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

Robert F. Dittmar

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
425
Abstract Views
4,185
rank
71,292
PlumX Metrics