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What difference do new factor models make in portfolio allocation?

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  • Fabozzi, Frank J.
  • Huang, Dashan
  • Jiang, Fuwei
  • Wang, Jiexun

Abstract

This paper compares the Hou-Xue-Zhang four-factor model with the Fama-French five-factor model from an investing perspective both in- and out-of-sample. Without margin requirements and model uncertainty, the Hou-Xue-Zhang model outperforms the Fama-French model. However, the outperformance could become negligible if an investor is subject to margin requirements and model uncertainty. The Hou-Xue-Zhang model shows similar power as the Fama-French model in describing the covariance matrix of asset returns. Overall, the two models do not make a difference for investing in a realistic setting.

Suggested Citation

  • Fabozzi, Frank J. & Huang, Dashan & Jiang, Fuwei & Wang, Jiexun, 2024. "What difference do new factor models make in portfolio allocation?," Journal of International Money and Finance, Elsevier, vol. 140(C).
    • Handle: RePEc:eee:jimfin:v:140:y:2024:i:c:s0261560623001985
    DOI: 10.1016/j.jimonfin.2023.102997
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    More about this item

    Keywords

    Portfolio allocation; Mean-variance analysis; Factor model; Asset pricing;
    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
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General

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