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Incremental variables and the investment opportunity set

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  • Fama, Eugene F.
  • French, Kenneth R.

Abstract

Variables with strong marginal explanatory power in cross-section asset pricing regressions typically show less power to produce increments to average portfolio returns, for two reasons. (1) Adding an explanatory variable can attenuate the slopes in a regression. (2) Adding a variable with marginal explanatory power always attenuates the values of other explanatory variables in the extremes of a regression’s fitted values. Without a restriction on portfolio weights, the maximum Sharpe ratios in the GRS statistic of Gibbons, Ross, and Shanken (1989) provide little information about an incremental variable’s impact on the portfolio opportunity set.

Suggested Citation

  • Fama, Eugene F. & French, Kenneth R., 2015. "Incremental variables and the investment opportunity set," Journal of Financial Economics, Elsevier, vol. 117(3), pages 470-488.
    • Handle: RePEc:eee:jfinec:v:117:y:2015:i:3:p:470-488
    DOI: 10.1016/j.jfineco.2015.05.001
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    References listed on IDEAS

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    More about this item

    Keywords

    Incremental variables; Investment opportunity set; Portfolio returns; Variable attenuation;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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