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Quest for a parsimonious factor model in the wake of quality-minus-junk, misvaluation and Fama-French-six factors

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  • Ali, Fahad
  • Ülkü, Numan

Abstract

Information about expected returns contained in Fama and French's (2018) six-factor model cannot explain the misvaluation (UMO) and quality-minus-junk (QMJ) factor premiums. Results from factor spanning tests, examination of numerous anomaly portfolios and the Barillas and Shanken (2017) and Barillas et al. (2020) procedures suggest that a parsimonious three-factor model comprising the Market, UMO and Momentum factors performs at least comparable to, and in many cases better than, the Fama-French six-factor model. QMJ does not improve the performance of the proposed three-factor model.

Suggested Citation

  • Ali, Fahad & Ülkü, Numan, 2021. "Quest for a parsimonious factor model in the wake of quality-minus-junk, misvaluation and Fama-French-six factors," Finance Research Letters, Elsevier, vol. 41(C).
    • Handle: RePEc:eee:finlet:v:41:y:2021:i:c:s1544612320316615
    DOI: 10.1016/j.frl.2020.101847
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    References listed on IDEAS

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    1. David Hirshleifer & Danling Jiang, 2010. "A Financing-Based Misvaluation Factor and the Cross-Section of Expected Returns," The Review of Financial Studies, Society for Financial Studies, vol. 23(9), pages 3401-3436.
    2. Fama, Eugene F. & French, Kenneth R., 2015. "A five-factor asset pricing model," Journal of Financial Economics, Elsevier, vol. 116(1), pages 1-22.
    3. Amit Goyal & Zhongzhi Lawrence He & Sahn-Wook Huh, 2018. "Distance-Based Metrics: A Bayesian Solution to the Power and Extreme-Error Problems in Asset-Pricing Tests," Swiss Finance Institute Research Paper Series 18-78, Swiss Finance Institute.
    4. Barillas, Francisco & Kan, Raymond & Robotti, Cesare & Shanken, Jay, 2020. "Model Comparison with Sharpe Ratios," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 55(6), pages 1840-1874, September.
    5. Frazzini, Andrea & Pedersen, Lasse Heje, 2014. "Betting against beta," Journal of Financial Economics, Elsevier, vol. 111(1), pages 1-25.
    6. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-1152, September.
    7. Bhootra, Ajay, 2019. "Momentum and the Halloween Indicator: Evidence of a new seasonal pattern in momentum returns," Finance Research Letters, Elsevier, vol. 31(C), pages 26-31.
    8. Eugene F. Fama & Kenneth R. French, 2016. "Dissecting Anomalies with a Five-Factor Model," The Review of Financial Studies, Society for Financial Studies, vol. 29(1), pages 69-103.
    9. Clifford S. Asness & Andrea Frazzini & Lasse Heje Pedersen, 2019. "Quality minus junk," Review of Accounting Studies, Springer, vol. 24(1), pages 34-112, March.
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    Cited by:

    1. Bradrania, Reza & Veron, Jose Francisco & Wu, Winston, 2023. "The beta anomaly and the quality effect in international stock markets," Journal of Behavioral and Experimental Finance, Elsevier, vol. 38(C).
    2. Lenia Mukoyi & Kanayo K. Ogujiuba, 2022. "Comparison of Multifactor Asset Pricing Models in the South African Stock Market [2000–2016]," JRFM, MDPI, vol. 16(1), pages 1-22, December.

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    More about this item

    Keywords

    Misvaluation factor; Quality-minus-junk factor; Fama-French six-factor model; Parsimonious factor model;
    All these keywords.

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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