Arbitrage Portfolios

Soohun Kim, Robert Korajczyk, Andreas Neuhierl and Wei JiangEditor

The Review of Financial Studies, 2021, vol. 34, issue 6, 2813-2856

Abstract: We propose a new methodology for forming arbitrage portfolios that utilizes the information contained in firm characteristics for both abnormal returns and factor loadings. The methodology gives maximal weight to risk-based interpretations of characteristics’ predictive power before any attribution is made to abnormal returns. We apply the methodology to simulated economies and to a large panel of U.S. stock returns. The methodology works well in our simulation and when applied to stocks. Empirically, we find the arbitrage portfolio has (statistically and economically) significant alphas relative to several popular asset pricing models and annualized Sharpe ratios ranging from 1.31 to 1.66.

JEL-codes: C38 C58 G12 (search for similar items in EconPapers)
Date: 2021
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Citations: View citations in EconPapers (5)

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The Review of Financial Studies is currently edited by Itay Goldstein

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