Bayesian solutions for the factor zoo: we just ran two quadrillion models

Svetlana Bryzgalova, Jiantao Huang and Christian Julliard

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We propose a novel, and simple, Bayesian estimation and model selection procedure for crosssectional asset pricing. Our approach, that allows for both tradable and non-tradable factors, and is applicable to high dimensional cases, has several desirable properties. First, weak and spurious factors lead to diffuse, and centered at zero, posteriors for their market price of risk, making such factors easily detectable. Second, posterior inference is robust to the presence of such factors. Third, we show that flat priors for risk premia lead to improper marginal likelihoods, rendering model selection invalid. Therefore, we provide a novel prior, that is diffuse for strong factors but shrinks away useless ones, under which posterior probabilities are well behaved, and can be used for factor and (non necessarily nested) model selection, as well as model averaging, in large scale problems. We apply our method to a very large set of factors proposed in the literature, and analyse 2.25 quadrillion possible models, gaining novel insights on the empirical drivers of asset returns.

Keywords: cross-sectional asset pricing; factor models; model evaluation; multiple testing; data mining; p-hacking; Bayesian methods (search for similar items in EconPapers)
JEL-codes: C11 C12 C52 C59 G12 (search for similar items in EconPapers)
Pages: 76 pages
Date: 2020-01-17
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http://eprints.lse.ac.uk/118924/ Open access version. (application/pdf)

Related works:
Journal Article: Bayesian Solutions for the Factor Zoo: We Just Ran Two Quadrillion Models (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:118924

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