SMU SOE Online Seminar (Sept 4, 2020, 4pm-5.30pm): Forest through the Trees: Building Cross-Sections of Stock Returns

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TOPIC:

FOREST THROUGH THE TREES: BUILDING CROSS-SECTIONS OF STOCK RETURNS

ABSTRACT We show how to build a cross-section of asset returns, that is, a small set of basis assets that capture complex information contained in a given set of stock characteristics. We use decision trees to generalize the concept of conventional sorting and introduce a new approach to the robust recovery of a low-dimensional set of portfolios that span the stochastic discount factor (SDF). Constructed from the same pricing signals as conventional double- or triple-sorted portfolios, our cross-sections have on average 30% higher Sharpe ratios and pricing errors relative to the leading reduced-form asset pricing models. They include long-only investment strategies that are well diversiﬁed, easily interpretable, and that could be built to reﬂect many characteristics at the same time. Empirically, we show that traditionally used cross-sections of portfolios and their combinations often present too low a hurdle for candidate asset pricing models, as they miss a lot of the underlying information from the original returns. Keywords: Asset pricing, sorting, portfolios, cross-section of expected returns, decision trees, elastic net, stock characteristics, machine learning. JEL Codes: G11, G12, C55, C58. Click here to view the paper. Click here to view the CV.		This seminar will be held via Zoom. A confirmation email with the Zoom meeting link will be sent the registered email by 3 September 2020.
		PRESENTER Svetlana Bryzgalova London Business School
		RESEARCH FIELDS Empirical Asset Pricing Financial Econometrics Macrofinance
		DATE: 4 September 2020 (Friday)
		TIME: 4.00pm - 5.30pm

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