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Discussion Paper Details

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Title: Taming the Factor Zoo: A Test of New Factors

Author(s): Gavin Feng, Stefano W Giglio and Dacheng Xiu

Publication Date: January 2020

Keyword(s): Elastic Net, Factors, Lasso, Machine Learning, PCA, Post-Selection Inference, Regularized Two-Pass Estimation, Stochastic discount factor and variable selection

Programme Area(s): Financial Economics

Abstract: We propose a model selection method to systematically evaluate the contribution to asset pricing of any new factor, above and beyond what a high-dimensional set of existing factors explains. Our methodology accounts for model selection mistakes that produce a bias due to omitted variables, unlike standard approaches that assume perfect variable selection. We apply our procedure to a set of factors recently discovered in the literature. While most of these new factors are shown to be redundant relative to the existing factors, a few have statistically significant explanatory power beyond the hundreds of factors proposed in the past.

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Bibliographic Reference

Feng, G, Giglio, S and Xiu, D. 2020. 'Taming the Factor Zoo: A Test of New Factors'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=14266