Principal Portfolios / Bryan T. Kelly, Semyon Malamud, Lasse H. Pedersen.

Format:

Book

Author/Creator:

Kelly, Bryan T.

Contributor:

National Bureau of Economic Research.

Malamud, Semyon.

Pedersen, Lasse H.

Series:

Working Paper Series (National Bureau of Economic Research) no. w27388.

NBER working paper series no. w27388

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2020.

Summary:

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.

Notes:

Print version record

June 2020.