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Portfolio Theory and Practice Read chapter Read first chapter

2023 | OriginalPaper | Chapter

9. Anomalies and Multifactor Models

Authors : James W. Kolari, Seppo Pynnönen

Published in: Investment Valuation and Asset Pricing

Publisher: Springer International Publishing

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Abstract

Fama and French (1992, 1993, 1995, 1996) proposed the three-factor model. Their model motivated researchers to propose other multifactor models. Here we review the four-factor models by Carhart (1997), Fama and French (2015), Hou, Xue, and Zhang (2015), and Stambaugh and Yuan (2017), in addition to a six-factor model by Fama and French (2018) as well as a machine learning and artificial intelligence (AI) model by Lettau and Pelger (2020). According to Cochrane (2011) a factor zoo exists nowadays with hundreds of different factors. A new challenge in asset pricing is: Which factors and models should we use?

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previous chapter Multifactor Models
next chapter A Special Case of the Zero-Beta CAPM: The ZCAPM
Appendix
Available only for authorised users
Footnotes
1
Novy-Marx (2013) also found that stock returns are related to expected profits.
 
2
Gordon (1962)  is famous for this simple valuation model.
 
3
In a later study by Barillas and Shanken (2018), various factors and models in previous studies were tested. Using novel tests of the relative performance of different models, in both in-sample and out-of-sample tests, they found that a six-factor model containing market, size, value, profit, investment, and momentum factors outperformed other possible models.
 
4
The 11 anomalies were: net stock issues, equity issuance, accruals, net operating assets, asset growth, investment to assets, financial distress, O-score of distress, momentum, gross profitability, and return on assets.
 
5
As cited in footnote 3, Barillas and Shanken (2018) tested this model also.
 
6
Beyond the scope of the present introductory text, this squared Sharpe ratio test of intercepts was based on work by Barillas and Shanken (2018), who developed the performance metric for comparing competing asset pricing models.
 
7
Barillas and Shanken (2018) tested different factors and models and found that a six-factor model with market, size, value, profit, investment, and momentum factors outperformed other models in both in-sample and out-of-sample tests.
 
8
Fama and French (2018) conducted a different kind of out-of-sample test for models by using a subsample of returns in the sample period for in-sample test statistics and then using the remaining returns in the same sample period for out-of-sample test statistics.
 
9
In regression models with an intercept term, OLS fits the model such that the average of the residuals, or \(E(e_{it})\), approximately equals zero. Without an error term in model (9.10) the average of the residual terms will not be zero and, therefore, is a good proxy for the mispricing alpha.
 
10
As in their 2015 study of the six-factor model, they applied maximum squared Sharpe ratio tests of the intercepts also (see footnote 6).
 
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Metadata
Title
Anomalies and Multifactor Models
Authors
James W. Kolari
Seppo Pynnönen
Copyright Year
2023
Book
Investment Valuation and Asset Pricing

Print ISBN: 978-3-031-16783-6

Electronic ISBN: 978-3-031-16784-3

Copyright Year: 2023

DOI
https://doi.org/10.1007/978-3-031-16784-3_9