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Arbitrage Portfolios

Author

Listed:
  • Soohun Kim
  • Robert A Korajczyk
  • Andreas Neuhierl
  • Wei JiangEditor

Abstract

We propose a new methodology for forming arbitrage portfolios that utilizes the information contained in firm characteristics for both abnormal returns and factor loadings. The methodology gives maximal weight to risk-based interpretations of characteristics’ predictive power before any attribution is made to abnormal returns. We apply the methodology to simulated economies and to a large panel of U.S. stock returns. The methodology works well in our simulation and when applied to stocks. Empirically, we find the arbitrage portfolio has (statistically and economically) significant alphas relative to several popular asset pricing models and annualized Sharpe ratios ranging from 1.31 to 1.66.

Suggested Citation

  • Soohun Kim & Robert A Korajczyk & Andreas Neuhierl & Wei JiangEditor, 2021. "Arbitrage Portfolios," The Review of Financial Studies, Society for Financial Studies, vol. 34(6), pages 2813-2856.
    • Handle: RePEc:oup:rfinst:v:34:y:2021:i:6:p:2813-2856.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhaa102
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    Citations

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    Cited by:

    1. Cakici, Nusret & Fieberg, Christian & Metko, Daniel & Zaremba, Adam, 2023. "Machine learning goes global: Cross-sectional return predictability in international stock markets," Journal of Economic Dynamics and Control, Elsevier, vol. 155(C).
    2. Francisco Peñaranda & Enrique Sentana, 2024. "Portfolio management with big data," Working Papers wp2024_2411, CEMFI.
    3. Clarke, Charles, 2022. "The level, slope, and curve factor model for stocks," Journal of Financial Economics, Elsevier, vol. 143(1), pages 159-187.
    4. Langlois, Hugues, 2023. "What matters in a characteristic?," Journal of Financial Economics, Elsevier, vol. 149(1), pages 52-72.

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • C38 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Classification Methdos; Cluster Analysis; Principal Components; Factor Analysis

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