Principal Portfolios

Bryan T. Kelly, Semyon Malamud, Lasse H. Pedersen

Publikation: Working paperForskning

Abstrakt

We propose a new asset-pricing framework in which all securities’ signals are used to predict each individual return. While the literature focuses on each security’s own-signal predictability, assuming an equal strength across securities, our framework is flexible and includes cross-predictability—leading to three main results. First, we derive the optimal strategy in closed form. It consists of eigenvectors of a “prediction matrix,” which we call “principal portfolios.” Second, we decompose the problem into alpha and beta, yielding optimal strategies with, respectively, zero and positive factor exposure. Third, we provide a new test of asset pricing models. Empirically, principal portfolios deliver significant out-of-sample alphas to standard factors in several data sets.
OriginalsprogEngelsk
UdgivelsesstedCambridge, MA
UdgiverNational Bureau of Economic Research (NBER)
Antal sider62
DOI
StatusUdgivet - jun. 2020
NavnNational Bureau of Economic Research. Working Paper Series
Nummer27388
ISSN0898-2937

Citationsformater