Taste for Characteristics or Risk Factor Aversion? Evidence from Institutional Demand

Abstract

We disentangle the relevance of risk factors versus stock characteristics not only by analyzing covariance patterns in the cross-section of returns, but also by employing the information content of institutional portfolio holdings. We show that demand from 13(f) investors is strongly affected by known stock characteristics but not so by risk factors. Furthermore, we find strong evidence that this characteristics-induced demand is pricing-relevant. Our approach helps to resolve the identification dilemma of reduced-form models. Robustness checks discard the concern that our results are driven by latent risk factors, poor factor proxies, micro-caps or that it can be easily arbitraged away.

Keywords: factor models, characteristics, anomalies, institutional investors

JEL Classification: G12