A1285
Title: Intrinsic factor risk premia and tests of asset pricing models
Authors: Alberto Quaini - Columbia University (United States) [presenting]
Fabio Trojani - University of Geneva, University of Turin and SFI (Switzerland)
Ming Yuan - Columbia University (United States)
Abstract: An intrinsic factor risk premium is given by the factor covariance with the maximum Sharpe ratio return out of a set of test assets. When the maximum Sharpe ratio is finite, intrinsic risk premia are well-defined and equal to zero for any factor, implying a zero or a vanishing correlation with returns. If a factor is not tradable, intrinsic risk premia are not consistently estimated by established cross-sectional two-step estimation methods. Therefore, we introduce an Oracle intrinsic risk premium estimator, which is asymptotically normal and consistently selects all intrinsically priced factors. Using our estimation and inference methodology based on intrinsic risk premia, we study a family of one to six-factor asset pricing models from the factor zoo. In this context, we clarify the key role of the interplay between misspecification and factor tradeability for understanding the pricing of factor risk and comparing asset pricing models.
