Discussion paper

DP14417 Asset Pricing vs Asset Expected Returning in Factor-Portfolio Models

Standard factor-portfolio models focus on returns and leave prices undetermined.
This approach ignores information contained in the time-series of asset prices, relevant for long-term investors and for detecting potential mis-pricing.
To address this issue, we provide a new (co-)integrated methodology to factor modeling based on both prices and returns.
Given a long-run relationship between the value of buy-and-hold portfolios in test assets and factors, we argue that a term---naturally labeled as Equilibrium Correction Term (ECT)---should be included when regressing returns on factors.
We also propose to validate factor models by the existence of such a term.
Empirically, we show that the ECT predicts equity returns, both in-sample and out-of-sample.

£6.00
Citation

Favero, C and A Melone (2020), ‘DP14417 Asset Pricing vs Asset Expected Returning in Factor-Portfolio Models‘, CEPR Discussion Paper No. 14417. CEPR Press, Paris & London. https://cepr.org/publications/dp14417