with Amedeo Andriollo and Xinyi Zhang, 2024, working paper.
[Paper] To explain the cross-section of asset returns, a “zoo” of economic factors that are not
portfolio excess returns has been proposed. In contrast to traded factors, the nontraded
factors tend to exhibit lower correlations with the asset returns. Standard inference
on risk premium therefore tends to be more fragile, and the issue of weak identification
might be exacerbated by the degree of model misspecification. Yet, robust
inference has often been overlooked by many empirical studies, while limited efforts
have been devoted to “domesticating” such factors. After re-evaluating the non-traded
factor zoo, we find that the vast majority of the original model specifications published
in top academic journals suffer from the aforementioned fragilities. Robust inference
indicates that most of the proposed non-traded factors are unpriced in the commonly
used portfolios. The findings are more drastic when considering multiple hypothesis
testing adjustments, or when incorporating the market factor as an additional control.
However, when summarizing the non-traded factors via PCA, we find that the zoo
does carry some non-zero pricing information.