Taming the Factor Zoo: A Test of New Factors
49 Pages Posted: 14 Jan 2020
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Taming the Factor Zoo: A Test of New Factors
Date Written: January 2020
Abstract
We propose a model selection method to systematically evaluate the contribution to asset pricing of any new factor, above and beyond what a high-dimensional set of existing factors explains. Our methodology accounts for model selection mistakes that produce a bias due to omitted variables, unlike standard approaches that assume perfect variable selection. We apply our procedure to a set of factors recently discovered in the literature. While most of these new factors are shown to be redundant relative to the existing factors, a few have statistically significant explanatory power beyond the hundreds of factors proposed in the past.
Keywords: Elastic Net, Factors, Lasso, Machine Learning, PCA, Post-Selection Inference, Regularized Two-Pass Estimation, Stochastic discount factor, variable selection
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