We propose a nonparametric method to study which characteristics provide incremental information for the cross-section of expected returns. We use the adaptive group LASSO to select characteristics and to estimate how selected characteristics affect expected returns nonparametrically. Our method can handle a large number of characteristics and allows for a flexible functional form. Our implementation is insensitive to outliers. Many of the previously identified return predictors don’t provide incremental information for expected returns, and nonlinearities are important. We study our method’s properties in simulations and find large improvements in both model selection and prediction compared to alternative selection methods. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.
Dissecting Characteristics Nonparametrically
Joachim Freyberger,Andreas Neuhierl,Michael Weber
Published 2020 in The Review of financial studies
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- Publication year
2020
- Venue
The Review of financial studies
- Publication date
2020-04-17
- Fields of study
Mathematics, Economics
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