LAUSR.org creates dashboard-style pages of related content for over 1.5 million academic articles. Sign Up to like articles & get recommendations!

The Cross-Section of Risk and Returns

Photo by sharonmccutcheon from unsplash

A common practice in the finance literature is to create characteristic portfolios by sorting on characteristics associated with average returns. We show that the resultant portfolios are likely to capture… Click to show full abstract

A common practice in the finance literature is to create characteristic portfolios by sorting on characteristics associated with average returns. We show that the resultant portfolios are likely to capture not only the priced risk associated with the characteristic but also unpriced risk. We develop a procedure to remove this unpriced risk using covariance information estimated from past returns. We apply our methodology to the five Fama-French characteristic portfolios. The squared Sharpe ratio of the optimal combination of the resultant characteristic-efficient portfolios is 2.13, compared with 1.17 for the original characteristic portfolios.

Keywords: risk; section risk; finance; characteristic portfolios; risk returns; cross section

Journal Title: Review of Financial Studies
Year Published: 2020

Link to full text (if available)


Share on Social Media:                               Sign Up to like & get
recommendations!

Related content

More Information              News              Social Media              Video              Recommended



                Click one of the above tabs to view related content.