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TOPIC:
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FOREST THROUGH THE TREES: BUILDING CROSS-SECTIONS OF STOCK RETURNS
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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.
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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.
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PRESENTER
Svetlana Bryzgalova
London Business School
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RESEARCH FIELDS
Empirical Asset Pricing
Financial Econometrics
Macrofinance
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DATE:
4 September 2020 (Friday)
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TIME:
4.00pm - 5.30pm
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