Arbitrage portfolios

Soohun Kim*, Robert A. Korajczyk, Andreas Neuhierl

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

5 Scopus citations

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.

Original languageEnglish (US)
Pages (from-to)2813-2856
Number of pages44
JournalReview of Financial Studies
Volume34
Issue number6
DOIs
StatePublished - Jun 1 2021

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics

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