Publication Type

Journal Article

Version

submittedVersion

Publication Date

9-2023

Abstract

We propose a reduced-rank approach (RRA) to reduce a large number of factors to a few parsimonious ones. In contrast to PCA and PLS, the RRA factors are designed to explain the cross section of stock returns, not to maximize factor variations or factor covariances with returns. Out of 70 factor proxies, we find that five RRA factors outperform the Fama-French (2015) five factors for pricing target portfolios, but performs similarly for pricing individual stocks. Our results suggest that existing factor proxies do not provide enough new information at the stock level beyond the Fama-French (2015) five factors.

Keywords

reduced rank, PCA, PLS, factors, factor model, cross section

Discipline

Corporate Finance | Finance and Financial Management

Research Areas

Finance

Publication

Management Science

Volume

69

Issue

9

First Page

5501

Last Page

5522

ISSN

0025-1909

Identifier

10.1287/mnsc.2022.4563

Publisher

INFORMS

Copyright Owner and License

Authors

Additional URL

https://doi.org/10.1287/mnsc.2022.4563

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