How Robust are Empirical Factor Models to the Choice of Breakpoints?

Fabian Hollstein (), Marcel Prokopczuk and Victoria Voigts
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Fabian Hollstein: School of Human and Business Sciences, Saarland University, Campus C3 1, 66123 Saarbrucken, Germany
Marcel Prokopczuk: School of Economics and Management, Leibniz University Hannover, Koenigsworther Platz 1, 30167 Hannover, Germany†ICMA Centre, Henley Business School, University of Reading, Reading RG6 6BA, UK
Victoria Voigts: School of Economics and Management, Leibniz University Hannover, Koenigsworther Platz 1, 30167 Hannover, Germany

Quarterly Journal of Finance (QJF), 2023, vol. 13, issue 04, 1-68

Abstract: We comprehensively investigate the robustness of well-known factor models to altered factor formation breakpoints. Deviating from the standard 30th and 70th percentile selection, we use an extensive set of anomaly test portfolios to uncover two main findings: First, there is a trade-off between specification and diversification. More centered breakpoints tend to result in less (idiosyncratic) risk. More extreme sorts lead to greater exposure to the underlying anomalies and thus to higher average returns. Second, the models are robust to varying degrees. Hou et al.’s model [2015, Digesting Anomalies: An Investment Approach, Review of Financial Studies 28, 650–705] is much more sensitive to changes in breakpoints than the Fama–French models.

Keywords: Empirical asset pricing; factor models; replication analysis; breakpoints; robustness (search for similar items in EconPapers)
JEL-codes: C58 G10 G12 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1142/S2010139223500118

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