Taming the Factor Zoo: A Test of New Factors

49 Pages Posted: 14 Jan 2020

See all articles by Guanhao Feng

Guanhao Feng

City University of Hong Kong (CityU)

Stefano Giglio

Yale School of Management; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Dacheng Xiu

University of Chicago - Booth School of Business

Multiple version iconThere are 2 versions of this paper

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

Suggested Citation

Feng, Guanhao and Giglio, Stefano and Xiu, Dacheng, Taming the Factor Zoo: A Test of New Factors (January 2020). CEPR Discussion Paper No. DP14266, Available at SSRN: https://ssrn.com/abstract=3518606

Guanhao Feng (Contact Author)

City University of Hong Kong (CityU) ( email )

83 Tat Chee Avenue
Hong Kong

Stefano Giglio

Yale School of Management ( email )

135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Dacheng Xiu

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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