Three Common Factors

Elena Andreou, Patrick Gagliardini, Eric Ghysels, and Mirco Rubin

♦ We present a set of novel theoretical results providing a solution that address for the perils of beta dynamics misspecification in the estimation of conditional asset pricing models. We show that the true factors are those common between conditional asset pricing models for individual stocks and models estimated from sorted portfolios. We find that there are at least three common factors. These are not entirely spanned by the three or five Fama-French factors, and are also related to some proxies of idiosyncratic risk and liquidity. The three factors feature superior out-of-sample pricing performance compared to standard asset pricing models.

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