High-Dimensional Factor Models and the Factor Zoo / Martin Lettau.

Format:

Book

Author/Creator:

Lettau, Martin.

Contributor:

National Bureau of Economic Research.

Series:

Working Paper Series (National Bureau of Economic Research) no. w31719.

NBER working paper series no. w31719

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2023.

Summary:

This paper proposes a new approach to the "factor zoo" conundrum. Instead of applying dimension-reduction methods to a large set of portfolios obtained from sorts on characteristics, I construct factors that summarize the information in characteristics across assets and then sort assets into portfolios according to these "characteristic factors". I estimate the model on a data set of mutual fund characteristics. Since the data set is 3-dimensional (characteristics of funds over time), characteristic factors are based on a tensor factor model (TFM) that is a generalization of 2-dimensional PCA. I find that parsimonious TFM captures over 90% of the variation in the data set. Pricing factors derived from the TFM have high Sharpe ratios and capture the cross-section of fund returns better than standard benchmark models.

Notes:

Print version record

September 2023.