%0 Generic %1 kozak2017shrinking %A Kozak, Serhiy %A Nagel, Stefan %A Santosh, Shrihari %D 2017 %K factor-empirical-test sdf zoo-factor %T Shrinking the Cross Section %U https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2945663 %X We construct a robust stochastic discount factor (SDF) that summarizes the joint explanatory power of a large number of cross-sectional stock return predictors. Our method achieves robust out-of-sample performance in this high-dimensional setting by imposing an economically motivated prior on SDF coefficients that shrinks the contributions of low-variance principal components of the candidate factors. While empirical asset pricing research has focused on SDFs with a small number of characteristics-based factors—e.g., the four- or five-factor models discussed in the recent literature—we find that such a characteristics-sparse SDF cannot adequately summarize the cross-section of expected stock returns. However, a relatively small number of principal components of the universe of potential characteristics-based factors can approximate the SDF quite well

@preprint{kozak2017shrinking, abstract = {We construct a robust stochastic discount factor (SDF) that summarizes the joint explanatory power of a large number of cross-sectional stock return predictors. Our method achieves robust out-of-sample performance in this high-dimensional setting by imposing an economically motivated prior on SDF coefficients that shrinks the contributions of low-variance principal components of the candidate factors. While empirical asset pricing research has focused on SDFs with a small number of characteristics-based factors—e.g., the four- or five-factor models discussed in the recent literature—we find that such a characteristics-sparse SDF cannot adequately summarize the cross-section of expected stock returns. However, a relatively small number of principal components of the universe of potential characteristics-based factors can approximate the SDF quite well}, added-at = {2019-02-26T17:16:10.000+0100}, author = {Kozak, Serhiy and Nagel, Stefan and Santosh, Shrihari}, biburl = {https://www.bibsonomy.org/bibtex/22bd9297e7d225f7950acec3df6ac4727/antoinefalck}, interhash = {fba76cb06b2c130a685d3ae8e8cc00fa}, intrahash = {2bd9297e7d225f7950acec3df6ac4727}, keywords = {factor-empirical-test sdf zoo-factor}, timestamp = {2019-03-06T20:45:42.000+0100}, title = {Shrinking the Cross Section}, url = {https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2945663}, year = 2017 }