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Cross-section without factors: a string model for expected returns

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  • Walter Distaso
  • Antonio Mele
  • Grigory Vilkov

Abstract

Many asset pricing models assume that expected returns are driven by common factors. We formulate a model where returns are driven by a string, and no-arbitrage restricts each expected return to capture the asset's granular exposure to all other asset returns: a correlation premium. The model predicts fresh properties for big stocks, which display higher connectivity in bad times, but also work as correlation hedges: they contribute to a negative fraction of the correlation premium, and portfolios that are more exposed to them command a lower premium. The string model performs at least as well as many existing linear factor models.

Suggested Citation

  • Walter Distaso & Antonio Mele & Grigory Vilkov, 2024. "Cross-section without factors: a string model for expected returns," Quantitative Finance, Taylor & Francis Journals, vol. 24(6), pages 693-718, June.
    • Handle: RePEc:taf:quantf:v:24:y:2024:i:6:p:693-718
    DOI: 10.1080/14697688.2024.2357189
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