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Evaluating the Importance of Missing Risk Factors Using the Optimal Orthogonal Portfolio Approach

In English

Författare

Summary, in English

We apply the orthogonal portfolio approach to analyse the importance of risk factors potentially missing from the CAPM. We generalize the approach proposed by MacKinlay and Pastor (2000) [MacKinlay, A.C., Pastor, L., 2000. Asset pricing models: implications for expected returns and portfolio selection. Review of Financial Studies 13, 883–916] by estimating the Sharpe ratio of the optimal orthogonal portfolio. Our result, based on US industry portfolios for the period 1927–2002, reveals important risk factors missing from the CAPM during periods with high market volatility. We show that a priori fixing the Sharpe ratio, which is an assumption used by MacKinlay and Pastor (2000) [MacKinlay, A.C., Pastor, L., 2000. Asset pricing models: implications for expected returns and portfolio selection. Review of Financial Studies 13, 883–916], may produce less plausible estimates of the expected returns.

Publiceringsår

2005

Språk

Engelska

Sidor

556-575

Publikation/Tidskrift/Serie

Journal of Empirical Finance

Volym

12

Issue

4

Dokumenttyp

Artikel i tidskrift

Förlag

North-Holland

Ämne

  • Economics

Nyckelord

  • Investment strategy
  • Orthogonal portfolio
  • Simulated annealing
  • Factor pricing

Status

Published

ISBN/ISSN/Övrigt

  • ISSN: 0927-5398