Forward Selection Fama-MacBeth Regression with Higher Order Asset-Pricing Factors

Nicola Borri, Denis Chetverikov, Yukun Liu and Aleh Tsyvinski

No 33663, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We show that the higher-orders and their interactions of the common sparse linear factors can effectively subsume the factor zoo. We propose a forward selection Fama-MacBeth procedure as a method to estimate a high-dimensional stochastic discount factor model, isolating the most relevant higher-order factors. Applying this approach to terms derived from six widely used factors (the Fama-French five-factor model and the momentum factor), we show that the resulting higher-order model with only a small number of selected higher-order terms significantly outperforms traditional benchmarks both in-sample and out-of-sample. Moreover, it effectively subsumes a majority of the factors from the extensive factor zoo, suggesting that the pricing power of most zoo factors is attributable to their exposure to higher-order terms of common linear factors.

JEL-codes: G0 (search for similar items in EconPapers)
Date: 2025-04
New Economics Papers: this item is included in nep-for
Note: AP
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Working Paper: Forward Selection Fama-MacBeth Regression with Higher-Order Asset Pricing Factors (2025)
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