An information based one-factor asset pricing model

Anisha Ghosh, Christian Julliard and Alex Taylor

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

Abstract: Given a set of asset returns, an information-theoretic approach is used to estimate non-parametrically the pricing kernel to price the given cross-section out-of-sample. Compared to leading factor models, this information SDF delivers smaller pricing errors and better cross-sectional fit, and identifies the maximum Sharpe ratio portfolio out-of-sample. Moreover, it extracts novel pricing information not captured by Fama-French and momentum factors, leading to an ‘information anomaly.' A tradable information portfolio that mimics this kernel has a very high out-of-sample Sharpe ratio, outperforming both the 1/N benchmark and the Value and Momentum strategies combined. These results hold for a wide cross-section of assets.

Keywords: pricing kernel; relative entropy; factor models; factor mimicking portfolios; alpha (search for similar items in EconPapers)
JEL-codes: C13 C53 G11 G12 G13 (search for similar items in EconPapers)
Pages: 32 pages
Date: 2016-04-01
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:118978

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