Principal Portfolios

Bryan T. Kelly, Semyon Malamud and Lasse Pedersen

No 27388, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We propose a new asset-pricing framework in which all securities’ signals are used to predict each individual return. While the literature focuses on each security’s own-signal predictability, assuming an equal strength across securities, our framework is flexible and includes cross-predictability—leading to three main results. First, we derive the optimal strategy in closed form. It consists of eigenvectors of a “prediction matrix,” which we call “principal portfolios.” Second, we decompose the problem into alpha and beta, yielding optimal strategies with, respectively, zero and positive factor exposure. Third, we provide a new test of asset pricing models. Empirically, principal portfolios deliver significant out-of-sample alphas to standard factors in several data sets.

JEL-codes: C1 C3 C58 C61 G11 G12 G14 (search for similar items in EconPapers)
Date: 2020-06
New Economics Papers: this item is included in nep-ore
Note: AP
References: View references in EconPapers View complete reference list from CitEc
Citations:

Published as BRYAN KELLY & SEMYON MALAMUD & LASSE HEJE PEDERSEN, 2023. "Principal Portfolios," The Journal of Finance, vol 78(1), pages 347-387.

Downloads: (external link)
http://www.nber.org/papers/w27388.pdf (application/pdf)

Related works:
Working Paper: Principal Portfolios (2020)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:nbr:nberwo:27388

Ordering information: This working paper can be ordered from
http://www.nber.org/papers/w27388

Access Statistics for this paper

More papers in NBER Working Papers from National Bureau of Economic Research, Inc National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.. Contact information at EDIRC.
Bibliographic data for series maintained by ().