The Cross-Section of Risk and Return

Kent Daniel, Lira Mota, Simon Rottke and Tano Santos

No 24164, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: In the finance literature, a common practice is to create characteristic portfolios by sorting on characteristics associated with average returns. We show that the resulting 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 and French (2015) characteristic portfolios. The squared Sharpe ratio of the optimal combination of the resulting characteristic efficient portfolios is 2.16, compared with 1.16 for the original characteristic portfolios.

JEL-codes: G00 G1 G12 G14 (search for similar items in EconPapers)
Date: 2017-12
New Economics Papers: this item is included in nep-fmk and nep-rmg
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

Published as Kent Daniel & Lira Mota & Simon Rottke & Tano Santos & Andrew Karolyi, 2020. "The Cross-Section of Risk and Returns," The Review of Financial Studies, vol 33(5), pages 1927-1979.

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Journal Article: The Cross-Section of Risk and Returns (2020)
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