Factors Common to Individual Stock and Sorted Portfolio Returns

Authors:

• Elena Andreou (University of Cyprus and CEPR)
• Patrick Gagliardini (Università della Svizzera italiana, Lugano and Swiss Finance Institute)
• Eric Ghysels (University of North Carolina - Chapel Hill and CEPR)
• Mirco Rubin (EDHEC Business School, Nice)

Abstract

There are two commonly used approaches to cross-sectional asset pricing, each with pros and cons. One consists of collecting stocks into portfolios and subsequently estimate risk exposures. The other consists of estimating cross-sectional risk premia using the entire universe of stocks. Applying a novel test, we identify the factor space common between individual stocks and sorted portfolios - neither affected by time-varying betas nor by the sorting characteristics. We find three factors - which can only partially be explained by Fama-French five factors with(out) momentum. Our three factors also feature superior out-of-sample pricing performance compared to standard pricing models.

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