Anomaly Predictability with the Mean-Variance Portfolio

Carlo A. Favero, Alessandro Melone and Andrea Tamoni
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Carlo A. Favero: Bocconi U
Alessandro Melone: Ohio State U
Andrea Tamoni: Rutgers U

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: According to a no-arbitrage condition, risk-adjusted returns should be unpredictable. Using several prominent factor models and a large cross-section of anomalies, we find that past cumulative risk-adjusted returns predict future anomaly returns. Cumulative returns can be interpreted as deviations of an anomaly price from the price of the mean-variance efficient portfolio. Price deviations constitute a novel anomaly-specific predictor, endogenous to the given heuristic mean-variance portfolio, thus providing direct evidence for conditional misspecification. A zero-cost investment strategy using price deviations generates positive alphas. Our findings suggest that incorporating price information into cross-sectional models improves their ability to capture time-series return dynamics.

JEL-codes: C38 G12 G17 (search for similar items in EconPapers)
Date: 2023-12
New Economics Papers: this item is included in nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2023-20

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